The biggest tail risk for global investors is eurozone sovereign debt funding, which has displaced commodity price inflation as investors’ main preoccupation, according to a survey conducted by Bank of America Merrill Lynch of 285 investors managing a combined $814 billion.

This is BoA Merrill’s monthly survey of global buy-side clients. It finds over the past month a sharp increase to 36% of respondents citing European sovereign debt as the biggest ‘tail risk’. A month ago only 21% felt this way. Commodity price inflation, seen as the biggest tail risk by 36% of respondents in April, is now only flagged by 16%.

Chinese real estate saw a modest increase in concern, with 12% rating it the biggest tail risk, up from 9% in April.

Framing this mood is a growing consensus that the US Federal Reserve will maintain very low interest rates throughout the year. Now 73% of respondents expect no change to US interest rates before 2012. Just one month ago, two-thirds of respondents predicted US rates would start to rise this year.

Although loose monetary policy in the US is being blamed for inflation, those concerns do not appear to be overly troubling most fund managers. That’s because investors have growing doubts about GDP growth prospects. As the US nears the completion of ‘QE2’, many fund managers are worried that the stimulants propping up the US economy won’t be replaced by commercial activity. Indeed, overall inflation expectations have moderated.

Despite this, risk appetite remains resilient, according to the survey’s blend of indicators. Hedge funds in particular seem more optimistic than a month before. Asset allocation has not changed much; the only notable shift has been a cut in the overweight position in commodities. Investors in aggregate remain overweight commodities, but by far less. Merrill speculates that any upside surprise this summer in oil or other commodity prices would see investors return quickly to greater overweights.

However, the survey finds global investors are making changes within asset classes. At a sector level, equity fund managers are rotating into more defensive positions, such as consumer staples, and out of resources, energy and banks (although in emerging markets, the favoured sectors are consumers and energy; and among Asia-based investors, hot sectors are industrials, tech and energy).

And emerging markets, which had experienced net selling in the first quarter, are now definitely back in favour, with the average investor 29% overweight, from neutral in March. This is now halfway back to EM’s peak overweight level recorded by this survey, in November 2010.

Merrill’s analysts suggest this reflects weaker global growth expectations, lower inflation expectations and elevated risk appetite. Investors based in Asia favour Taiwan and China, and have been trimming positions in India, the Philippines and most dramatically in Australia.

Most of the flows came at the expense of the US, which had been the main beneficiary in the first quarter, although investors are still modestly bullish on it.

Moreover investors consider the US dollar still undervalued; in fact, in terms of this survey’s history, investors say it is the most undervalued since August 2008. The euro, in contrast, is seen as overvalued. Other currencies saw little major change in expectations.