Institutional investors are at their most optimistic about the global economy since December 2005, according to latest Merrill Lynch Survey of Fund Managers. However, the prolonged banking crisis seems to be stopping them from putting cash into equities, Merrilly Lynch says.

For the first time in more than three years, investors do not predict lower global economic growth over the next 12 months, Merrill reports. “Renewed optimism about China’s economy lies at the heart of this revival,” it says, as two months ago 70% of respondents thought China’s economy would worsen in the year ahead, but that is down to just 1%.

At the same time, its survey finds that investors’ risk appetite has dropped, with pessimism towards banks at a record high. It reports that 48% of asset allocators said they are underweight banks this month, up from 39% in February. Also, 22% said they are aggressively underweight banks, versus 17% in February. Respondents are noticeably bearish about Japanese and eurozone equities, it adds.

March’s survey shows signs that investors want to believ“e in an economic recovery. However, caution on banks is firmly capping risk appetite,” said Gary Baker, Banc of America Securities-Merrill Lynch co-head of international investment strategy.

“How investors resolve this anomaly between growth optimism and risk reluctance will determine the fate of equity markets this spring,” said Michael Hartnett, Banc of America Securities-Merrill Lynch co-head of international investment strategy.

For now it appears that fear is winning out. Merrill reports that it found that risk appetite took a marked downward turn in March despite the improved economic outlook. Respondents say they have reduced their equity exposure in the past month while increasing cash holdings and fixed-income investments, it says, as 41% are now underweight equities, up from 34% in February.

Instead investors appeared to have flooded into bonds, it says, with 26% overweight the asset class, up sharply from 7% the previous month. Also, average cash balances rose to 5.2% from 4.9% in February.

There are early signs of recovery however, it notes. As 42% believe equities are undervalued, up from 24% in February. Changes in sector allocation also indicate a movement out of the most defensive stocks, it adds.

Additionaly, while the U.S. continues to fuel economic optimism, investors have become more bullish about emerging markets, especially China, it says. “Optimism on growth has been expressed with higher weightings in emerging markets equities and commodities,” said Hartnett.

In contrast, investors have further reduced equity investment in the eurozone and Japan. “Investors might look to review their extreme underweight positions in eurozone and Japanese equities if economic data follow growth expectations higher,” Hartnett said.

A total of 213 fund managers, managing a total of US$533 billion, participated in the global survey from March 6 to 12.

IE