Investors predict Europe will fall into recession over the next 12 months because of fears about sovereign debt burdens and the plight of the region’s banks, according to the monthly Bank of America Merrill Lynch fund manager survey.

The September poll found that 55 per cent of European fund managers predict the region will endure two successive quarters of decline – the technical definition of recession – over the next year. In July, only 14 per cent of such managers made the same forecast.

Europe’s sovereign and banking challenges dominate risks identified by global asset allocators. Some 68 per cent of survey respondents now view the eurozone debt crisis as the largest of these risks, up from 43 per cent in June and 60 per cent in August. Sentiment towards European banks is at its lowest since the survey began asking about it in January 2003.

The past month has seen fears continue to build about the future of the eurozone and the risk that Greece, for example, may default on its debt, possibly leading to it leaving the currency bloc and throwing the region into disarray.

While other regions also suffered, sentiment towards the US improved slightly. Only a net 9 per cent of US fund managers now expect the economy to weaken in the next year. Global investors also restored an overweight position in US equities.

Among fund managers across all regions, the survey found that more than one-third of investors are overweight cash, holding an average 4.9 per cent of portfolio assets as cash, notwithstanding poor yields.  

Reduced risk appetite is also evident in hedge funds’ exposures. The sector has cut its net long position to 19 per cent, down from 33 per cent a month earlier. Investors’ assessment of market liquidity has also turned to a net negative.

Sentiment towards bonds has improved as investors have turned negative on equities. Global asset allocators have halved their underweight in the asset class in just two months – from a net 45 per cent in July to a net 21 per cent now. Other asset classes also benefited from a shift out of equities. Most notably, the global underweight in real estate halved month-on-month, to a net 7 per cent.

Meanwhile, the growth slowdown has altered investors’ view of oil. A net 14 per cent of respondents view the commodity as overvalued, up from a net zero per cent in August.

With inflation fears having largely receded, investors have turned their focus to fiscal policy. A net 23 per cent view it as too restrictive for the current phase of the business cycle, compared to the net 19 per cent who viewed it as too stimulative just two months earlier.

A total of 203 fund managers, managing a total of $648 billion, participated in the global survey.