GLOBAL - Risk aversion has risen sharply on the back of turmoil in credit markets yet fund managers have failed to radically shift their portfolios, according to Merrill Lynch.

Merrill Lynch's global fund manager survey for September found while the credit market turbulence is starting to feed through into equity market fundamentals, investors still appear to favour stocks over bonds.

Despite concerns about business cycle risk, Merrill said fund managers show no sign of positioning their portfolios for a downturn.

"Investors believe that equities are undervalued, suggesting they sense a buying opportunity within months," the survey noted.

The mean equity weighting has fallen only three percentage points since July to 53%, and 23% of investors said they view equities as undervalued, up from 11% in August.

Furthermore, 37% of survey respondents said they would increase their equities exposure - up from 29% the previous month. Two-thirds remain underweight in bonds.

"Investors say they are worried about business cycle risk, but asset allocators have yet to start reshaping their portfolios for a different environment," said David Bowers, independent consultant to Merrill Lynch and joint managing director of Absolute Strategy Research.

"This begs the question of whether they are in denial about the possible extent of this downturn."

Risk aversion has risen sharply with investors holding cash levels of more than 4.3%, and shortening their investment horizon to an extent not seen since March 2003.

Some 34% of fund managers surveyed described liquidity conditions, in terms of market depth, as ‘negative' just two months after 75% described them as ‘positive'.

Growth expectations are deteriorating and concerns of monetary policy being ‘too stimulative' have diminished, Merrill Lynch said.

Business cycle risk has also emerged as a significant threat to market stability with 61% describing it as above normal, up from 32% in August.

A total of 188 fund managers, managing $615bn, participated in the global survey between September 7 and 13.

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