Allocations to EM equities plummet despite rising risk appetite

Allocations to emerging-market equities saw their fastest ever one-month fall in February to hit their lowest point since March 2009, a Bank of America-Merrill Lynch survey finds.

Just 5% of global fund managers are now overweight emerging markets (EM), compared with 43% in January, according to the data. In contrast, global investors have turned more bullish on global equities than at any time in the past decade.

Further, a net 66% are now underweight bonds, up from 54% in January, and 9% are underweight cash – the lowest allocation since 2002. In fact, the difference between equity overweights and bond underweights has now reached its highest level since the survey began.

Unusually, it means higher global risk appetite has been accompanied by a dramatic downsizing in asset allocations to emerging markets, notes Gary Baker, head of European equities strategy at BoA Merrill global research.

A net 67% of respondents are now overweight global equities – the highest reading since the survey began asking this question in April 2001 – compared with 40% in December.

Appetite for eurozone equities rose sharply, with 11% overweight in February, from a 9% underweight in January. Meanwhile, a net 34% of respondents are overweight US equities, up from 16% in December.

“The dramatic decline in EM positions must be placed in the context of rising global equity positioning to record levels,” BoA Merrill notes in its report. “Indeed with cash balances down to 3.5%, all equity markets are vulnerable to a correction.”

The survey found a net 58% of global investors expect the world economy to strengthen this year, a slight increase on last month, while 68% anticipate a rise of 10% or more in corporate profits, compared with 45% of respondents who felt the same way in January.

Fears of a double-dip recession have vanished, with a net 92% now expecting no recession in the coming 12 months.

But a net 75% expect global inflation to increase this year – the highest reading since June 2004 – up from 48% three months ago. “It was only six months ago that we were debating a deflation scare in global markets,” the report states.

A key component of inflation – commodity prices – now ranks as investors’ biggest risk. A net 33% now rank it ahead of all other threats, from 13% in January.

Tellingly, growth expectations for China fell to -27%, the lowest level since June 2010. It is this combination that has caused the huge rotation from EM to US and European equities.

“We believe immediate downside risk for EM equities is now low following capitulation,” finds the report. “But we believe a peak in EM inflation or upside surprises to China growth are necessary to provoke fresh inflows to EM.”

Fund managers’ greater risk appetite is reflected in a strong rotation between equity sectors. Underweights in banks and insurers fell to a net 7% each, from 21% and 15% in January, respectively. They turned negative on pharmaceuticals, and intensified their negative stance on consumer discretionary, consumer staples and utilities.

Regional differences underlie these global shifts. With EU sovereign funding no longer as pronounced a concern as in January, European respondents trimmed their underweight on banks by 40 points to 16%. In contrast, US investors turned more negative towards the sector.

Within emerging markets, investors extend a huge preference for Europe, the Middle East and Africa (net +50% overweight) over Asia (-6%) and Latin America (-44%). Russia (+88%) and Turkey (+44%) are most preferred, while investors scaled back positions in Brazil (-19%) to their first underweight in the survey’s history.

Their favoured sectors remain consumer discretionary (+38%), technology (+31%) and energy (+19%). They have rotated away from EM materials (+13%) and industrials (0%) towards financials (+6%). Their least favoured remain the defensive sectors of staples, healthcare and utilities.

Asia-Pacific investors left their market positions broadly unchanged, extending allocations to their favoured markets: Taiwan (+33%), Korea (+17%) and China (+13%). Their least favoured remain India (-20%), Indonesia (-17%) and Australia (-13%).

Technology (+53%) and energy (+33%) are most favoured, while materials (+20%) and industrials (+27%) are cut sharply. Staples (-47%), utilities (-47%) and healthcare (-27%) are least favoured.