Global investors have increased cash and scaled back risk-taking amid fears of geopolitical instability and questions about the strength of the global economic recovery, according to the BofA Merrill Lynch Fund Manager Survey for May.

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A total of 218 panelists with US$587 billion AUM participated in the survey; 170 managers, managing US$455 billion, participated in the global survey; 106 managers, managing US$230 billion, participated in the regional surveys.

Investors are sitting on more cash and have reduced equity holdings compared to a month ago. Average cash levels have reached 5% of portfolios – the highest level since June 2012 and up from 4.8% in April. A net 22% are taking below normal levels of risk, up from 11% a month ago. The proportion of asset allocators overweight equities has fallen to a net 37% from a net 45% last month.

Respondents to the global survey are confident that both the world economy and corporate performance are improving, but question the rate of growth. A net 66% of the panel expects the economy to strengthen in the coming 12 months, up from a net 62% in April. A net 49% say that corporate profits will rise in the coming year, up five percentage points month-on-month. But nearly three-quarters (72%) predict “below trend” growth for the global economy, and a net 20% say it’s unlikely corporate profits will grow by 10% or more in the year ahead.

Investors also see two major risks to market stability. One-third of the global panel believes that the risk of Chinese debt defaults poses the biggest tail risk. And 36% say a geopolitical crisis is the greatest threat.

“Investors are showing belief in the economy but with two big question marks: Are we on the brink of a disruptive event? And why, at this point in the cycle, isn’t this recovery stronger?” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research.

“Specifically, within Europe, investors are all aboard the periphery train, and there’s now simply no margin for error. Spanish and Italian equities are preferred over those in the U.K. and Switzerland, while eurozone periphery debt is seen as the most crowded trade globally,” said Obe Ejikeme, European equity and quantitative strategist.

Momentum builds behind Europe

European equities have bucked the broader monthly trend of seeing allocations scaled back, and investors have indicated the positive flows should continue. A net 36% of global asset allocators say they are overweight eurozone equities, up from a net 30% in April. Allocations to other developed markets, namely the U.S. and Japan, fell month-on-month.

Europe is also the region most in favor looking ahead. A net 28% say that it’s the region they most want to overweight in the coming 12 months, up from a net 23% a month ago. A net 14% say that European equities are undervalued.

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The U.S. is the least-favored region with a net 18% saying it’s the region they most want to underweight, up from a net 9% in April. Forward-looking sentiment for emerging markets has improved slightly over the past month and a net 3% say it’s the region the most want to overweight.

Nonetheless, the panel has sounded two warnings about European assets. First is that significantly more investors say that being long EU periphery debt is the most crowded trade – 35% of the panel take that view this month, up from 19% in April. Investors also continue to see the euro as the most overvalued currency, with 58% of the panel taking that view ahead of ECB governor Mario Draghi hinting towards policies that could lead to weakness in the euro.

European investors’ view of their region reflects the global perspective. They forecast economic growth, but a net 30% predict less than 10% corporate profit growth in the region. Average cash balances have risen to 4.8%, from 3.8% in April.

Global sector switches reflect risk-off stance

Changes in global sectoral equity allocations from April to May reinforced the sense of investors scaling back risk. The biggest positive swings were towards Utilities and Energy, with a net 15% of investors increasing their allocations to these more defensive sectors. A net 14% of investors scaled back positions in Banks, and a net 8% reduced holdings in Technology.

While investors have increased their cash levels close to two-year highs, they remain keen to see companies put their cash to work. A net 66% of the global panel says that corporates are under-investing, up two percentage points on April’s figure. And 60% say that “increasing capital spending” is the best use of cash flow, up from 58% last month.

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