Investors’ allocations to equities have risen to their second highest level in 13 years, with China and Japan gaining favour at the expense of the eurozone, according to Bank of America Merrill Lynch’s (BoA-Merrill) July fund manager survey*.

But overall exposure to emerging market equities is unchanged month-on-month and remains far below the long-term historical average, despite the segment being seen as the most undervalued in 13 years. (This view was supported by a Northern Trust survey, to which 64% of respondents said they thought EMs were undervalued.**)

Despite improving sentiment towards EM equities, they continue to be under-owned relative to allocation data collected since 2001, although a net 61% of global asset allocators are OW equities overall.

EM investors swung heavily in favour of China (19% UW to 20% OW) and Asia-Pacific investors increased their OW to 14% from 5%. Despite this big jump, China was cited as posing the joint biggest tail risk, with a net 28% of respondents putting a debt default top of their worries, admittedly lower than the 37% last month. Geopolitical risk was the other most-cited risk.

A net 26% of managers are now OW Japan equities, the highest allocation in five months and up from 21% in June and 7% in May, according to the BoA-Merrill survey. That marks a continuing reversal of sentiment from earlier this year, when the effects of the Abenomics stimulus measures seemed to be waning.

Sixty-nine percent of respondents to Northern Trust’s poll said the increase in sales tax to 8% from 5% that happened in April would only have a limited impact on Japanese stocks. Further, 41% view Japanese equities as undervalued, up from 32% in last quarter’s survey.

India remains by far the most heavily favoured EM globally, according to the BoA-Merrill survey. A net 47% of EM managers are overweight the market, down from around 75% last month and 50% in May, but up from 44% in April. Asia-Pacific investors also grew less bullish on India, moving from a net 23% OW to 7% OW.

Meanwhile, Indonesia fell out of favour: global EM managers switched to a net 10% UW from a net 10% OW and Asia-Pacific investors moved from a net 1% OW to a net 4% UW.

However, Asia-Pacific investors grew more bullish on Thailand, which went from 16% UW to 1% OW. But global EM investors disagreed, with a net 19% underweight the country in July up from 10% last month.

Asia-Pacific managers also turned more bullish on Taiwan, which moved from a net 14% OW to 23% OW, and South Korea (11% OW to 14% OW). But they were more bearish on Hong Kong (4% UW to 11% UW), Malaysia (8% UW to 15% UW) and Singapore (4% UW to 15% UW). Sentiment towards Korea and Malaysia was unchanged month-on-month at a net 9% UW and 58% UW, respectively. 

Conviction on European equities continues to weaken, with a net 10% of respondents now looking to overweight the region in the next year, down 11 percentage points from June’s response. Allocation to the region fell in July to a net 35% OW from 43% OW last month.

Bearishness is strengthening because investors now expect quantitative easing by the European Central Bank to occur later than previously anticipated. Further, investors are souring towards peripheral eurozone debt, with managers saying US high-yield debt is now the most crowded trade, a reversal from last month.

Though expectation of inflation globally is on the rise, hitting its highest level since March 2011, a net 69% of respondents forecast that world economic growth will strengthen over the next year.

• A total of 228 panellists with $674 billion of assets under management participated in the survey from July 3-10. A total of 113 managers with combined AUM of $293 billion took part in the regional survey.

** Northern Trust polled more than 150 investment managers, but did not divulge their AUM.