Fund managers gravitate to cash amid stock-market volatility

New survey shows that fund managers have reassessed their appetite for risk following recent market turmoil, writes Claire Shoesmith.

The recent volatility in the world's stock markets will have gone unnoticed by few. In Ireland, the shock headlines, such as €4 billion wiped off the value of Irish shares in one day, couldn't have failed to attract the attention of even the most disinterested of onlookers - after all, most of us have a pension and the majority of those are invested, at least in some proportion, in equities.

As a result, it is pleasing to note that the so-called experts - the fund managers and global investors to whom many of us entrust our savings or retirement funds - are also sitting up and taking notice. In many cases, they have reduced their exposure to equities. (Two days of turmoil at the end of February were enough to plunge Irish pension funds into the red for the month, with the average managed fund losing half a percentage point during the month, despite strong gains by equity markets over the first three weeks of February.)

According to the latest Merrill Lynch survey of fund managers, conducted in the midst of all the turmoil, investors around the world have reassessed their appetite for risk in the wake of the sell-off in stock markets that started on February 27th.

Since then, world markets are trading about 3 per cent lower, with the Iseq index of Irish shares being no exception - down almost 5 per cent.

As a result, portfolio managers have increased their cash balances sharply, from 3.8 per cent to 4.4 per cent, with a net 30 per cent of survey respondents saying they are now overweight in cash.

Moreover, according to Merrill Lynch, investor appetite for risk is at one of its lowest levels for the past five years, with the average investment time horizon being just seven months.

"Investor visibility is at its poorest since the spring of 2003, when Iraq was invaded and fears of global deflation were high," says David Bowers, independent consultant to Merrill Lynch.

"That risk has been repriced is not a surprise. What is interesting is the extent to which this sell-off reflects a more fundamental reassessment by investors of global macro prospects."

Despite the signs of a recovery in world markets - London's FTSE, Dublin's Iseq and the Dow Jones and Nasdaq in the US have all gained in value every day so far this week - almost two-thirds of fund managers questioned believe equity volatility is likely to be higher a year from now.

Still, looking at a six-month time line, the majority thinks it is unlikely that world markets will be lower than they are today. So, while the volatility is expected to continue, investors believe there is money to be made in the long run.

On a local level, this backs up the sentiment expressed by Irish commentators who, despite the recent declines, are confident the Iseq can not only continue to rise, but can again outperform its European counterparts.

This positive outlook seems to be shared globally, with Merrill Lynch saying that the sentiment among fund mangers remains generally good, despite the recent stock-market declines. Investors, the bank says, are sticking by their outlooks for the economy irrespective of the recent turmoil.

"While they are slightly more cautious about the prospects for economic growth and corporate profits, only 10 per cent of panellists believe that a global recession is likely in the next 12 months," Merrill Lynch said, adding that while its growth expectations composite indictor shows a bearish reading of 34, sentiment is stronger than in the last two months of 2006.

Still, while investors appear not to be concerned about the risk of a global macroeconomic slowdown, they do believe that the US Federal Reserve should be worried about the US outlook.

Some 45 per cent of asset allocators believe the Federal Reserve should be more concerned by the threat of slower economic growth, suggesting that while investors are relaxed about the global outlook, they are concerned about the possibility of increased risks associated with cross-boarder investment.

"On a 12-month view, fund managers have no doubt they would rather be underweight in US equities and overweight in euro-zone stocks," Merrill Lynch said.

Investors' opinions on the US outlook are relevant even for local markets such as Ireland, in the light of the fact that much of the volatility - particularly in a downwards direction - has been attributed to events in the US.

On several days during the recent declines, the Irish market fell considerably despite strong earnings from Irish companies, with traders attributing the falls to sentiment in the US.

As for future direction, local traders are constantly looking further afield for signs of the direction the market might take, and there is little doubt that the US will take the lead in this area.

There is, however, some light on the investment horizon, according to Merrill Lynch, with asset allocators, who are currently sheltering in cash, planning to increase their exposure in equities. Some 25 per cent of these investors intend to increase their equity investments over the next three months.

Merrill lynch questioned a total of 199 fund global managers between March 9th and 15th. Between them, they manage a total of $668 billion (€500 billion). A further 173 regional managers, accounting for $412 billion worth of investments, were also interviewed.