Optimism about China growth has sunk dramatically over the past month amid a darkening inflation outlook, yet Asia-Pacific investors have increased their China positions, a survey finds.

Meanwhile, average cash levels only ticked up slightly to 3.6% in December, from 3.5% the month before – still extremely low. It indicates that investor risk appetite remains very high, raising concerns about possible overheating and future downside risk.

According to the latest monthly fund manager survey from Bank of America-Merrill Lynch, expectations both for global growth and inflation are rising among global investors. 

In December, a net 44% said they expected global growth to strengthen in 2011, up from zero in September. But at the same time a net 12% think China growth will weaken – a sharp deterioration from November, when a net +16% looked for stronger Chinese growth.

“Inflation is a concern,” says strategist Jacky Tang of BoA Merrill. “The latest figures for China inflation are 5.1%, and people are expecting inflation to go to a pretty high level in the next quarter or two, so that is creating concern for global investors.”

However, BoA Merrill’s Asia-Pacific survey – which admittedly references a far smaller number of respondents – reveals that investors in the region increased their China positions by 15% in December.

Acknowledging the difference in sample size, Tang reasons: “Asean is pretty expensive after the recent run-up, while for the more export-driven economies of Korea and Taiwan, for example, there are global concerns over inventory rebuilding as well as over the European sovereign crisis.

“And India, if you look at valuations, is not cheap. So China may be the place that Asian investors are returning to after the recent sell-off, even though global investors have become more cautious on China growth.”

The global survey, which does not include Asia-Pacific investors, reveals that emerging markets remain the equity region of choice with a net 50% of asset allocators overweight. While this is slightly down from 56% in November, it is still high historically.

Emerging-market investors maintained a big overweight exposure to consumer discretionary (+62%), although positions were trimmed this month. A net +8% are overweight financials – sharply down from +38% last month. Materials became an overweight (+8%) as a beneficiary of rising inflation expectations.

EM investors’ favoured countries remain Russia (+50%) and Turkey (+42%). A net +4% are overweight China, down sharply from +29% last month as growth optimism wanes. Taiwan (-42%) and Malaysia (-46%) remain big underweights, although exposures were scaled back in December.

In contrast, Asia-Pacific investors increased their positions in Taiwan (+18%), Korea (+15%) and China (+15%). India (-18%) is now the least preferred market, and Asia-Pacific investors trimmed their underweight positions in Australia (from -18% in November to -12% this month).

Technology (+53%), industrials (+35%) and energy (+29%) are their most preferred sectors. The defensive sectors of utilities (-65%), telecoms (-47%) and staples (-35%) are the least preferred.