Institutional investors remained on the sidelines as the cross-currents of political risk, economic fundamentals and higher volatility continued to dampen sentiment in July, according to State Street Global Markets.

However, the firm’s risk appetite index rose modestly to a neutral 0.00 level (Figure 1) as the risk-off bias to flows in June faded.

“Japan remains the biggest regional story and a surprise hike by the Bank of Japan (BOJ) at the end of July came against a backdrop of very strong buying of the Japanese yen,” says Timothy Graf, head of macro strategy for EMEA at State Street Global Markets.

“Yen holdings are now overweight and, if monetary policy elsewhere continues to ease while the BOJ continues to hike, we would expect the long-undervalued yen to continue seeing flow support.”

Meanwhile, Asian equities continued to see outflows amid strong selling of semiconductor shares. Flows into Chinese equities remained neutral, with the recent Third Plenum of the 11th Communist Party central committee “offering no substantive guidance for how to think about local markets over the medium term”, Graf adds.

Long-term investor allocations to equities rose 37 basis points to 53.6% while those to fixed income grew 43bp to 27.9%, and consequently, cash holdings saw the largest drop since last November, according to the State Street Holdings Indicators (Figure 2).

“After a sharp rise last month, institutions had a bit more comfort in allocating away from cash this month. However, allocations to both equities and fixed income rose, underscoring the nervous and neutral stance in aggregate,” says Graf.