Global fund manager allocations to UK equities have hit the lowest point since the financial crisis as a potential Brexit becomes the largest perceived “tail risk” to their strategies.
A net 36 per cent of managers in the Bank of America Merrill Lynch (BAML) Fund Manager Survey were underweight UK equities in May, up from a net 20 per cent in April.
Brexit has now overtaken “quantitative failure” – the risk that stimulus programmes fail – as the biggest tail risk.
Manish Kabra, BAML European equity quantitative strategist, said: “Investors identify Brexit as the biggest tail risk in the world, with global fund managers’ allocations to UK equities dropping to the lowest levels in seven and a half years.”
However, the majority of managers still expect the UK to remain in the EU, with 71 per cent suggesting a departure was unlikely.
That may be why sterling is seen as undervalued by a net 20 per cent, which BAML said was the second-highest reading on record.
The fall in UK sentiment was the largest negative change month-on-month.
At the other end of the scale, net weightings to emerging market equities rose by almost 10 percentage points, despite a Chinese recession or risk of Chinese corporate defaults being seen as the second-largest tail risk by respondents.
European stocks remained a favourite among global managers, but the dwindling interest observed over recent months continued. Managers are wary of the possibility that the euro’s depreciation may be over, BAML said, with equity positions in Europe and emerging markets “rapidly converging”.
“This reflects manager sentiment on [foreign exchange rates], where expectations of euro depreciation peaked in March last year – coinciding with a peak in allocations to European stocks,” the report said.
Nonetheless, a net 39 per cent expected the European economy to strengthen over the next 12 months, up sharply from 6 per cent in April.
Overall allocations to equities dropped from a 9 per cent overweight to a 6 per cent overweight. Allocations to bonds also fell three percentage points, to a 41 per cent underweight from 38 per cent in April.
Cash allocations, by contrast, have crept higher to 5.5 per cent in May. The net percentage of European fund managers that are overweight cash rose by two percentage points to 37 per cent.
Michael Hartnett, chief investment strategist for BAML, said: “Investors hold elevated cash levels to protect against potential shocks from Brexit, China and quantitative failure.”
Fund managers’ concern over US political risk also rose sharply in a month where both Donald Trump and Hillary Clinton came a step closer to securing presidential nominations.
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