Investor appetite for risk assets deteriorated sharply in September amid concerns about China and emerging markets, with fund managers' allocations to equities falling to their lowest levels in three years, a survey from Bank of America Merrill Lynch showed.
According to the monthly fund manager survey published on Tuesday, exposure to emerging market equities remained at a record low while bonds and cash benefited from heightened risk aversion.
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The threat of recession in China, the world's second largest economy, and an emerging market default meanwhile were seen by 75 percent of fund managers surveyed as the biggest tail risks.
The survey highlights the vulnerability of global financial markets in a week where the U.S. Federal Reserve may opt to lift record low interest rates for the first time in almost a decade.
"Investors were already positioned for lower growth in China and emerging markets, but their risk-off stance has intensified. Contrarians will be noting the aggressive underweight positioning in emerging markets," Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research, said in a release.
A total of 214 fund managers with $593 billion of assets under management were polled by BofA ML between September 4 and 10.
Global equity markets suffered hefty selling in August amid heightened concerns about a sharper-than-anticipated slowdown in China and uncertainty about the timing of U.S. rate rises.
According to the survey, the percentage of investors expecting the U.S. Federal Reserve to hike rates this week fell to 25 percent from 48 percent last month.
The S&P 500 index, a broad gauge of U.S. stocks, tumbled about 6 percent in August, while China's Shanghai Composite index shed more than 10 percent of its value.
BofA ML said that asset allocation to global equities fell to a three year low and marked the biggest month-on-month drop in four years.
According to the report, there was an "unambiguous flight-to-quality," reflected by a large rise in weightings towards cash and bonds while exposure to stocks in Japan and the U.K. were reduced.
And after the recent bout of market volatility, one in three investors viewed stocks as the most vulnerable asset class to any tightening in Fed monetary policy.
"European equities have been hurt by the risk-off trade, but they remain a favored market," James Barty, head of European equity strategy, said in the BofA ML release.
On Chinese shares, which have been on a rollercoaster ride this year, investors were more bearish than bullish on the outlook -- 52 percent expected a lower market while 35 percent anticipated a rising market.
Most crowded trade?
Asked what they thought was the most crowded trade, 27 percent of investors polled by BoA ML said "long dollars" – in other words a bet that the dollar would strengthen.
The dollar index, a measure of the dollar's value against other major currencies, has retreated from a 12-year high set this year.
Still, latest market positioning data suggests traders continue to bet on the dollar strengthening as the Fed looks to tighten its monetary policy at a time when other major central banks remain on an easing path.