Italian political ructions and fears of a US-China trade war persuaded European money managers to dial back allocations to equities and emerging markets in May, while raising bond holdings to the highest since July 2016. Reuters' latest monthly survey of investors was carried out May 14-29, a time when 10-year US yields rose to seven-year highs above 3 percent, oil prices jumped to $80 a barrel and Italy's massive bond and equity selloff sent the euro to multi-month lows by evoking memories of the 2011-2012 crisis.
World shares stand some 8 percent below the record highs hit in January.
Cedric Baron, head of multi-asset at Generali Investments, said while he remained "constructive" on equities, "in a more volatile environment and with the resurgence of some political risks, we prefer to be less aggressive on this asset class, and to temporarily reduce the risky exposure of the portfolio".
Aside from political risk in Italy, investors were also fretting about inflation, driven by oil price rises, and central bank policy tightening, Baron added.
The share of equities in European funds' global portfolios fell almost 2 percentage points versus April to 41.7 percent, the lowest since November 2016. Debt allocations rose 2.6 percentage points to nearly a two-year high of 43 percent, the poll showed. "Protectionism and the risk of US inflation accelerating remain our primary concerns. However, developments in Italy are also a growing material risk that could (prompt) a dramatic shake out in risk assets," said Colin Harte, senior portfolio manager at BNP Paribas Asset Management.
The poll was conducted at a time when the United States and China held talks on trade, though both sides have repeatedly lashed out at each other with tariff threats.
Fund managers showed a marked preference for US assets, raising the share of US debt to the highest since last May. However, while the dollar has steadily risen in recent weeks, few investors appear bullish on it - only one poll respondent had changed their end-2018 forecast on the US currency. Fewer than 20 percent of those who replied to a special question said they would be tempted to buy US Treasury bonds at a 3 percent yield.
Raphael Gallardo at Ostrum Asset Management, an affiliate of Natixis Investment Managers, said he had always predicted an end-2018 euro-dollar rate of $1.15, given the yield and interest rate advantage of the United States over other developed markets. But he said he would not buy Treasuries at 3 percent.
Jan Bopp, an investment strategist at J Safra Sarasin, is also bearish, considering it premature to rush in at 3 percent. "We believe the market is underpricing the pace of future Fed rate hikes," he added.
A major victim of the recent dollar surge is the developing world, where currencies such as the Turkish lira and Argentine peso have fallen sharply, forcing authorities into sharp interest rate rises or direct interventions.
Average emerging local debt yields have risen almost half a percent since the start of the year. In the poll, investors cut their exposure to emerging market bonds by almost 3 percentage points to 13.7 percent.
Just over half of those who answered a special question said the recent upheaval had persuaded them to cut emerging market exposure but most remained bullish on long-term prospects.
"Emerging markets are adjusting to tighter financial conditions with spread widening and currency depreciation of the idiosyncratic stories in a sort of perfect storm," said Pascal Blanque, chief investment officer at Amundi.
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