Institutional investors are cautious overall, but bullish on China once again, finds the BofA Merrill Lynch Survey of Fund Managers for September.

The survey says that global investors are approaching the fourth quarter “with a heightened sense of caution.” One key signal of low risk appetite, according to Merrill, is large numbers of investors simultaneously saying that equities are undervalued and bonds are overvalued. A net 38% of the panel believe equities are undervalued while a net 68% believe bonds are overvalued.

Asset allocators reduced their underweight positions in fixed income, so that 15% are now underweight bonds, down from a net 23% in August. Investors are also moving to overweight cash positions. A net 20% of the panel was overweight cash this month, double the level in August, Merrill says.

Global sector allocations also highlight a more defensive approach, the survey finds. Asset allocators have sharply reduced their underweight positions in utilities, and more respondents are overweight pharmaceuticals than one month ago, it reports. At the same time, asset allocators have scaled back positions in industrials and technology.

Gold, another safe haven, is perceived as increasingly overvalued at a time when it has been approaching a new record high, Merrill notes.

Despite this overwhelming sense of caution, sentiment towards the Chinese economy has also swung from significantly bearish to bullish in just one month, Merrill reports. It says that a net 11% of respondents believe that the Chinese economy will strengthen over the next 12 months — a 30% swing and the largest positive monthly change since May 2009. In July, a net 39% were bearish on China.

Investors have followed through on this conviction with a stampede into Chinese equities, the survey finds. And, it says, global emerging markets remain the most favoured region for equities, while investor sentiment is broadly neutral towards the U.S., the eurozone and the U.K., and more bearish towards Japan.

“Despite subdued risk appetite, two thirds of investors view European equities as cheap, the highest reading since February 2003. This offers scope for a rally should economic news improve,” said Gary Baker, head of European Equities strategy at BofA Merrill Lynch Research.

“Renewed optimism in Chinese economic growth provides some hope of an improvement in investor sentiment in the coming months. The question is whether China is a sufficient catalyst to spark a change,” added Michael Hartnett, chief global equities strategist at BofA Merrill Lynch Research.

A total of 215 fund managers, managing a total of US$579 billion, participated in the global survey from September 2 to 9.

IE