Greater confidence in the strength of global growth and an improving appetite for risk has prompted a more pro-cyclical stance on the part of institutional investors, according to Merrill Lynch’s Survey of Fund Managers for July.

NEW YORK and LONDON, July 18, 2007 – Greater confidence in the strength of global growth and an improving appetite for risk has prompted a more pro-cyclical stance on the part of institutional investors, according to Merrill Lynch's Survey of Fund Managers for July.

The FMS Composite Index of Growth Expectations rose again this month to 46, its highest level in more than a year. The net balance of those expecting the global economy to strengthen over the next 12 months now stands at minus 5 percent, sharply up from April's figure of minus 29 percent. Corporate profit expectations also rebounded strongly, with only a net 12 percent expecting the outlook for corporate profits to deteriorate over the next year, versus 38 percent who took this view in April.

At the same time, the FMS Composite Indicator of Risk Appetite and Liquidity rose to 42 from 40, bringing it in line with its five-year average. Only a net 12 percent of the panel report below normal risk appetite, down from 18 percent in June. Significantly, cash balances fell to 3.4 percent from 3.7 percent last month, the lowest level recorded by the survey.

"Despite recent jitters in global credit markets, institutional investors are fully invested in equities with a strong cyclical bias," said David Bowers, independent consultant to Merrill Lynch.

Emerging markets are the major beneficiary of a more bullish outlook and the up-tick in risk appetite, with asset allocators aggressively raising their exposure to global emerging market equities at the expense of the U.S. and Eurozone. A net 35 percent of these respondents say they are overweight emerging market equities, up from 16 percent just one month ago.

Michael Hartnett, chief global emerging markets equity strategist at Merrill Lynch, said the survey shows the extent to which emerging markets have been able to shrug off credit worries seen in the U.S. subprime mortgage market. "Emerging markets continue to be in the midst of a substantial secular bull move. However, the strength of the recent rally — which has seen GEM equities up 35 percent from their March 2007 lows — may result in some profit-taking," said Mr. Hartnett.

Pro-cyclical industrial sectors have also benefited from stronger growth expectations and higher appetite for risk. At the global sector level, the big winner is the technology sector. A net 26 percent of survey respondents say they are overweight technology, sharply up from 16 percent in June. Consistent with this more pro-cyclical stance, investors have reduced their exposure to consumer staples and pharmaceuticals and are also favouring other economic sensitive sectors such as energy, industrials and materials.

In a new question this month, we asked asset allocators to rate seven potential risks to financial market stability. Respondents were asked to score each risk in terms of the threat they thought it posed to financial market stability. The risk that is most elevated at present is credit (default) risk, regarded by a net 72 percent of the panel as above normal.

This is followed by monetary risk (higher interest rates and/or more volatile exchange rates) at a net 44 percent. The threat to financial stability from protectionism and geopolitics is also seen as high and both score a net 39 percent. Asset allocators appear to be least concerned about emerging market risk, with a net 18 percent viewing this threat as below normal. Investors also remain relaxed about business cycle risk, with only a net 8 percent of asset allocators regarding the threat of financial instability from a more volatile business cycle as above normal.

With credit risk being the biggest threat to financial stability (as above), we look at the impact on the European market. If financial markets do face a major credit event, then private equity deals, which support market valuations, will become more expensive as the risk premium on credit rises. However, the impact on stock market valuations is likely to be less worrying for Europe than the U.S. "In Europe the proportion of LBOs in relation to total M&A activity for 2006 and 2007 is 18 percent and 13 percent, while in the U.S. the equivalent numbers are significantly higher at 27 percent and 37 percent," said Karen Olney, head of European equity strategy at Merrill Lynch.

A total of 186 fund managers participated in the global survey from 6 July to 12 July, managing a total of U.S. $618 billion. A total of 180 managers participated in the regional surveys, managing U.S. $447 billion. The survey was conducted with the help of market research company Taylor Nelson Sofres (TNS). Through its international network in more than 50 countries, Taylor Nelson Sofres provides market information services in over 80 countries to national and multi-national organizations. It is ranked as the fourth-largest market information group in the world. Survey results were analysed by David Bowers, who is joint managing director of Absolute Strategy Research Ltd, a financial services consultancy.

Merrill Lynch Global Securities Research & Economics Group has consistently achieved high rankings for its equity and fixed income research in numerous regional and global investor surveys, such as Institutional Investor, The Wall Street Journal, LatinFinance, Asiamoney, Euromoney, Extel and Reuters.

Merrill Lynch is one of the world's leading wealth management, capital markets and advisory companies, with offices in 38 countries and territories and total client assets of approximately $1.7 trillion. As an investment bank, it is a leading global trader and underwriter of securities and derivatives across a broad range of asset classes and serves as a strategic advisor to corporations, governments, institutions and individuals worldwide. Merrill Lynch owns approximately half of BlackRock, one of the world's largest publicly traded investment management companies with more than $1 trillion in assets under management. For more information on Merrill Lynch, please visit www.ml.com.