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Adviser Fund Index

Despite tentative signs of optimism creeping into this month’s Merrill Lynch Fund Manager Survey, the Adviser Fund Index panellists are not ready to abandon their defensive positioning.

In February’s Merrill Lynch Global Survey of managers, only a net 6 per cent saw the global economy weakening further over the next 12 months against a net 24 per cent in January. However, the shift in outlook was not reflected in a move of asset allocation with a net 34 per cent of managers retaining their sharp underweight in equities.

Like the respondents to the Merrill survey, the AFI panellists have yet to see sufficient economic signals of a recovery to start shifting their portfolios to a more aggressive stance.

“I think if we were rebalancing, what you would find is that there wouldn’t be many changes,” says Ben Willis, the head of research at Whitechurch Securities.

Tim Cockerill, head of research at Rowan, says equity markets have enjoyed rallies during the crisis but these have proven short-lived bear market bounces.

“On the current outlook, I would remain defensive,” says Cockerill. “In these markets there are short periods where optimism seems to be justified. If you take a step back, however, I think I would want to stay defensive in anticipation of more bad news to come.”

Recent falls pushed the FTSE 100 index under 4,000, underlining the fact that volatility remains in equity trading and it is still uncertain if the bottom of the market has been reached.

“I would like to see the markets looking better in the longer term, which we are not seeing yet,” says Cockerill. “I feel we are going to see increasing numbers of redundancies and more companies going bust. To really see something changing, you need to see positives across numerous indicators and not just for one month but for two or three.”

Consensus in the market appears to suggest that things could still get worse on a macroeconomic level. The Merrill Lynch survey showed that manager sentiment towards banks remains negative as their heavy underweight stayed constant over the month.

“It seems very difficult to envisage any sustained equity rally unless you see better sentiment coming through on banks,” says Gary Baker, head of EMEA equity strategy group at Bank of America-Merrill Lynch.

With the news that the American government may increase its stake in Citigroup to as much as 40 per cent, troubles in the banking sector seem far from having abated.

“I think February might be quite telling as I suspect things will get worse,” says Cockerill.

But Willis says one of the earliest signs of a recovery will not be seen in the equity market. With bond markets pricing in severe default risk, some investors are finding the risk/reward profile of investment grade fixed income compelling.

“The potential returns from investment-grade corporate debt are really interesting,” says Willis. “The market is pricing in defaults of 40 per cent over the next five years but they are unlikely to go much higher than 2 per cent so you are being paid to take on that risk.”

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