Record numbers of fund managers across the globe are taking higher-than-usual risk in their portfolios, according to Bank of America Merrill Lynch (BofA ML) research, as signs of “irrational exuberance” in markets continue to grow.
The BofA ML Global Fund Manager Survey for November shows that a net 16 per cent of asset allocators report above-normal levels of risk in their investment portfolios, which is a record high reading for the report.
The research, which was conducted between 3 and 9 November with fund managers running a total of $553bn, highlighted a number of reasons behind this trend.
Record number of fund managers taking higher than normal risk
Source: BofA ML Global Fund Manager Survey
According to the survey, the consensus view of the global economy is now a ‘Goldilocks’ one with a record 55 per cent of investors saying they expect global growth to be above-trend while inflation is likely to remain below trend.
Meanwhile, the balance of those expecting below-trend economic growth and inflation (or ‘secular stagnation’) has fallen to 25 per cent – which is the lowest reading since May 2011 and a “total reversal” from the levels seen in June last year.
Given this, the allocation to equities has risen to a net 49 per cent overweight, which is the highest recorded for the survey since April 2015. The current allocation to the asset class is now “high”, at 0.8 standard deviations above its long-term average.
Fund managers also tend to be overweight cyclical areas such as technology, banks, consumer discretionary and basic materials, the survey found, while being underweight traditional defensives like utilities and consumer staples.
When it comes to geographical allocations, a net 47 per cent of investors are overweight eurozone equities, a net 43 per cent are overweight emerging market stocks and a net 23 per cent are overweight Japanese equities.
However, analysts at Bank of America Merrill Lynch argue that the latest findings of the closely watched survey could offer cause for concern.
A net 48 per cent of the asset allocators said they believe equities are overvalued, which is a record high for the research.
At the same time – and suggesting a degree of capitulation into risk assets – the average cash balances of global fund managers have fallen from 4.7 per cent in October to 4.4 per cent in November.
Record ‘excess’ valuation in BofA ML Global Fund Manager Survey
Source: BofA ML Global Fund Manager Survey
This is the lowest level since October 2013 and below the 10-year average of 4.5 per cent. Fund managers’ allocation to cash has fallen to a net 23 per cent overweight, which is the lowest since May 2017 and 0.3 standard deviations above its long-term average.
Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, said: “Icarus is flying ever closer to the sun and investors’ risk-taking has hit an all-time high.
“A record high percentage of investors say equities are overvalued yet cash levels are simultaneously falling, an indicator of irrational exuberance.”
Furthermore, the survey found that the net share of investors taking out protection against a correction in markets decreased this month to minus 37 per cent, again suggesting that concerns over valuations have been pushed onto the back burner.
The BofA ML Global Fund Manager Survey also polled fund managers on what they see the biggest tail risks to markets being at the moment – and, despite their exuberance, they came up with plenty of options.
In top spot was a policy mistake from the US Federal Reserve or the European Central Bank (ECB), both of which have unveiled plans to rein in their monetary stimulus packages. Some 27 per cent of fund managers cited this as the main tail risk, up from the levels last month.
Fund managers are split on the likely impact of Fed balance sheet reduction and ECB tapering on stock markets with 42 per cent expecting lower stock prices but 35 per cent tipping stocks to go higher.
In second and third place are a crash in global bond markets (tipped by 22 per cent) and ‘market structure’ causing a flash crash (which worries 13 per cent). Neither of these tail risks were highlighted by the asset allocators contributing to last month’s survey.
What fund managers consider to be the biggest tail risk
Source: BofA ML Global Fund Manager Survey
North Korea is one that have been present for several months given the concerns over the ambition and pace of the country’s nuclear weapon programme.
Investors also flagged a bubble in the Nasdaq as a potential tail risk, having not mentioned this in October. Keeping in mind that technology is the biggest overweight of the asset allocators taking part in the survey, fund managers also said they consider the Nasdaq to be the market’s most crowded trade at the moment.