Institutional investors are more risk averse now than they have been in seven years, according to Merrill Lynch’s Survey of Fund Managers for February.

Fears over the economy and corporate profitability have stimulated a rise in portfolio cash levels to an average of 4.7%, up from 3.9% in January, it reported. Now, 41% of fund managers are overweight cash, the highest since September 2001’s attacks on the US. Also, risk appetite has plunged to new lows with a net 40% taking a lower level of risk than normal. And, about 30% say they have hedged against further falls in equities over the next three months.

“Risk aversion is so extreme and cash levels are so high, that the challenge is now to identify the catalyst that prompts money to return to the stock market,” said David Bowers, independent consultant to Merrill Lynch. “While it’s not clear what that catalyst will be, there’s no doubt that the ability to draw a line under the credit crunch will be an important step.”

Merrill said that deep down, investors still like equities. However, concern over the credit crunch’s impact on corporate and economic health is making them nervous. Now, 25% of respondents believe that equities are undervalued; three months ago just 5% did.

The number of respondents who forecast a deterioration in corporate profits over the coming 12 months has risen to 68%, up from 57% in January. And, the percentage of managers who believe the global economy is in recession has doubled for the second month running to 16%, while the number who think a global recession is ‘likely’ in the next 12 months rose to 28%, up from 19% in January.

Investors’ four-year love affair with continental European stocks has ended, Merrill observed. Only 7% of asset allocators are overweight eurozone equities compared with 23% in January. “Eurozone investors are asking for rate cuts, worried not by inflation, but by a potential collapse in growth,” said Karen Olney, chief European equities strategist at Merrill Lynch. “Investors are sending a clear signal that they expect a raft of downgrades to consensus earnings forecasts – 96% of respondents say these forecasts are too high.”

“The market is pricing in 75 basis points of interest rate cuts, but given the inflationary outlook we simply do not believe that the ECB has room to manoeuvre and deliver these cuts,” said Guillaume Menuet, European economist at Merrill Lynch.

A total of 190 fund managers participated in the global survey from February 1 to 7, managing a total of US$587 billion.