EUROPE – Corporate pension fund deficits are hindering the recovery of the global economy, says Merrill Lynch’s top investment strategist.

“Pension fund deficits are one of the key factors undermining economic recovery,” said David Bowers, the firm’s global chief investment strategist.

The need for companies to top up their pensions provides further competition for already stretched cash flow, he said, alongside the rebuilding of balance sheets via the repayment of debt.

With less cash to invest in expansion, companies’ growth is hit, he said. Bowers made the remarks at a presentation of Merrill Lynch’s February survey of fund managers’ investment expectations.

The rebuilding of balance sheets is in line with fund managers’ wishes. The survey found that 53% of those surveyed want companies to increase their debt repayments.

The key findings of the survey, according to Bowers, were the growth in fund managers’ risk aversion and the growth in managers’ holdings of cash.

“This survey has risk aversion in spades,” Bowers said. The report found that fund managers were more risk averse in January than after the September 11 terrorist attacks. Thirty-four percent of managers are now running a lower risk investment strategy.

Net cash balances had “risen quite sharply”, to 4.9% from 4.2% in December. European fund mangers were clutching even higher cash balances, the survey found – up to 5.2% of assets from 4.3% a month earlier. Almost one in six survey respondents had cash levels of 12% or more, Bower noted.

Some of the growth in cash was due to the decline in the equity component of portfolios, said Michael Hartnett, Merrill Lynch’s director of European equity strategy and economics. Risk aversion was “most vivid” in the euro-zone excluding the UK, Hartnett said.

One factor in the survey was that the euro was now seen as fairly valued, compared to the prior month when it was seen as undervalued. The UK is now seen as a safe haven, with the world’s best quality of corporate earnings.

Overall, the survey “does not say that the bull market starts today,” Hartnett said, though it suggests the market is more vulnerable to a bounce than a collapse. However, Bowers and Hartnett said they were bearish over the longer term for equities.

Bowers said Merrill was concerned that interest rate cuts haven’t kick-started the global recovery yet – which suggests there is another factor behind the lack of recovery. He cited the balance sheet and pension issues as unheralded factors.

Around half of the 308 survey respondents thought equities were undervalued, with 25% saying they believe stocks are undervalued by 15% or more. Bowers said this was an “extreme perception of valuation”.

As for the outlook for the economy and corporate profitability, the survey found that 62% expect the global economy to be stronger in a year’s time, down from 69% last month. Sixty-seven percent expect the outlook for corporate profits to improve, down from 77%. But the euro-zone was the least favourable region for corporate profits, with a –34% score.

Just 46% of euro-zone fund managers thought the region’s economy would be stronger in a year, down from 49% in January and 65% in December. Seventy percent felt the European Central Bank’s policy was too restrictive and 64% saw euro-zone stocks are undervalued.

Merrill surveyed 308 fund managers, controlling around 714 billion dollars in assets. Seventy-four respondents were euro-zone or pan-European specialists.