The latest edition of Merrill Lynch’s Fund Manager Survey finds a resurgence in risk aversion amid choppy equity markets.

The survey reports that average cash balances rose to 4.7% in July, up from 4.2% in June. “Having been fleetingly underweight all the big defensive sectors, investors have started reversing their stance,” it observes, noting that 11% of respondents are now overweight pharmaceuticals, a traditional safe-haven, compared to a net 2% underweight in the sector for June. Exposure to consumer staples and telecoms also rose, it said.

Conversely, investors are pulling back from more cyclical sectors. The percentage of investors overweight materials, a highly cyclical sector, fell to 1% in July from 15% in June.

Despite the nervousness surrounding equity markets, confidence in the global economic recovery remains strong, the survey found. It reported that 79% believe that global growth will improve in the next 12 months, more or less unchanged from June.

“July’s survey shows confidence in global markets remains very fragile. Investors believe the worst is over for the economy but are very narrowly positioned for recovery in emerging markets and technology stocks,” said Michael Hartnett, Banc of America Securities-Merrill Lynch chief global equities strategist.

“The market has duly delivered on investors’ universal wish for a market pullback, which now poses the question of whether investors have the courage of their convictions to invest for economic recovery in the second half of the year,” said Gary Baker, Banc of America Securities-Merrill Lynch head of European equity strategy.

Despite the apparent reduction in risk taking, investors are increasing their allocations to emerging markets, at the expense of investment in Europe and the U.S. “Decoupling is having a sequel. Investors are very overweight emerging market equities while at the same time underweight every other equity region,” said Hartnett.

Almost half of respondents say that emerging markets is the region they most want to be overweight. At the same time, investors have become more negative about equities in both the eurozone and the U.S. “European respondents are starting to believe that an end to recession is in sight, but their equity allocations show they are becoming more, rather than less, defensive,” it said.

“European investors’ defensiveness has left them overweight just four out of 19 sectors. If the macroeconomic outlook is correct, then these extreme underweight positions are looking unsustainable,” said Patrik Schowitz, Banc of America Securities-Merrill Lynch European equity strategist.

The latest survey, involving 221 fund managers, managing a total of US$635 billion, was completed from July 2 to 9. The survey was conducted by Banc of America Securities-Merrill Lynch Research with the help of market research company TNS.

IE