A sharp rise in risk appetite has seen investors rush headlong into emerging market (EM) equities amid expectations of a second wave of quantitative easing, according to a global fund manager survey.

Rising risk appetite has historically been positive for EM equities, and so it has proved again. The Bank of America-Merrill Lynch survey, carried out this month, found its risk appetite index had leapt to its highest level since April last year.

A net 49% of global investors are now overweight emerging markets, compared with 32% in September – a starling one-month rise of 17 percentage points. Appetite for US, European and Japanese equities, meanwhile, remained stable.

It was the survey’s highest reading for emerging markets for almost a year, with researchers pointing out that positioning is not yet at extreme levels. However, the bank suggests sentiment looks stretched relative to other markets, particularly Japan.

The last time the emerging market-Japan position was so stretched (last November), emerging markets went on to underperform Japan by 9% over the following three months.

“While improved risk appetite is to be welcomed, one proviso is just how narrow the investor focus on global emerging markets (GEM) is at this point,” says Michael Hartnett, chief global equities strategist at BoA Merrill global research.

Recently Morgan Stanley moved to start scaling back its overweight position in Asia and EM equities, noting that the asset class has recorded a cumulative $47 billion of inflows over 20 straight weeks.

The US bank initially installed a 6% overweight on Asia/EM equities back on May 26, since when the MSCI EM has risen 31.8%. But it says they have now become technically overbought, with 41% of Asia/EM stocks within 5% of their 52-week highs, versus a long-run average of 13.7%.

Asia/EM valuations have also adjusted back up to long-run average levels on metrics such as consensus 12-month forward price-to-earnings (P/E), notes Morgan Stanley.

Plus it points to economic data indicating the risk of a double dip could be rising, with new orders less inventories dipping into negative territory in the US Institute for Supply Management survey, as has exports from Taiwan to China.

But the bank underlines it is withdrawing from EM exposure gradually amid the likelihood that equity valuations may overshoot. It notes a new round of liquidity creation would stimulate US dollar weakness and likely imply a period of prolonged upward pressure on EM currencies.

Furthermore, economic expansion in emerging markets is forecast to be robust in 2011, with double-digit earnings growth a possibility and equities still appearing cheap compared with bonds.

In the BoA Merrill fund manager survey overall, the proportion of asset allocators overweight equities nearly tripled to a net 27%, from 10% in September, while they extended underweight positions in bonds. The proportion of portfolio managers overweight cash fell to a net 6%, from 18%.

Managers said they were more optimistic about the outlook for China’s growth -- a net 19% expect the country’s economy to strengthen in the next year, a hefty 38 percentage points above August’s level.

Demand for commodity exposure also recovered strongly, with a net 17% of fund managers overweight in October compared with 4% the previous month.

Asset allocators shifted their defensive sector positions back towards cyclical and growth stocks. A net 25% of respondents are underweight utilities, from 11%, while the biggest gains were seen in industrials, materials and technology.

Further, a net 41% said they would like to see corporates pay out surplus cash or make acquisitions, and a net 43% want them to raise more debt, up from 34% and 35%, respectively, in September.

But sentiment towards US and Eurozone equities continues to vacillate, with a net 4% underweight on the US and a net 3% underweight on Europe.

While growing numbers of investors believe the US dollar is undervalued, the prospect of quantitative easing in the US is countering potential dollar appetite and raising expectations of inflation. The proportion of investors predicting higher global inflation jumped to a net 27%, from 9% in September.

A net 45% of fund managers now regard the US dollar as undervalued (from 18% last month), and the same proportion see the euro as undervalued. But only 12% expect the dollar to gain against a basket of key currencies over the next year.

A total of 194 fund managers with $492 billion in all participated in the global BoA Merrill survey. Meanwhile, 167 managers, holding $392 billion, took part in its regional survey.