It is the billion-dollar question that, more than any other, could affect fund performance in 2011: when do investors move away from the reflation trade of emerging markets, commodities, resource stocks and small caps to developed markets and more defensive blue-chip industrial and finance stocks?

After a strong rally in 2010, emerging markets have begun to retreat as inflation expectations build and Asian central banks step on the brakes with interest rate rises. The MSCI BRIC index is down almost 3 per cent to date this year. In contrast, share markets in developed nations, such as the United States and in Europe, are off to a better start. The S&P 500 index is up 7 per cent so far in 2010. More funds are flowing from emerging markets to developed markets.

BT Investment Management global macro strategist Joe Bracken has favoured US and European equity markets over emerging markets since the third quarter of 2010. "The emerging markets have been a great growth story, but a lot of the good news has been priced in. Emerging markets look reasonably expensive now compared to developed markets," Bracken said.

"We still believe in the long-term story for emerging markets. However, in the short term, inflation expectations are rising, and the risk is that Asian central banks choke off inflation fears with aggressive rate moves, which are bad for equities in the short term. We see demand for Asian exports picking up from the US and Europe, but not by enough to sustain the type of growth emerging markets have experienced."

He said he expected further gains in US and European equity markets this year. "There was a lot of talk about economic recovery last year, but very little economic data to back it up. The majority of data now suggests the world economy is moving from a recovery to expansion phase. I still expect reasonably modest growth rates, but compared to where we have been and relative to average market valuations, that level of growth will, if anything, see us slightly more aggressive this year."

Andrew Sneddon, portfolio manager of Russell Investments' multi-asset class portfolios, still favours growth assets at this stage of the economic cycle. "What we are seeing is fairly typical for this early part of the cycle. There is nothing particularly extraordinary about growth assets doing well as economies recover. This is the time where you usually get rewarded for holding growth assets, although there is plenty of potential for setbacks and periods of 'risk on, risk off' markets. The European sovereign debt crisis and a bigger sell-off in the bond market are threats we are watching," Sneddon said.

He said his funds focused on growth assets at the start of 2010 - a position that worked well. "Now we are seeing better relative value in more defensive assets, such as industrial stocks," he said.

His fund has a neutral weighting towards large-cap mining stocks and is underweight in gold stocks, some of which he believed were overvalued. "We have a bias towards cyclical industrial stocks that have lagged the broader rally and have potential to improve as economies expand," he said.

"We like some multinational industrial companies that are well placed to benefit from emerging markets growth."

He said he believed the Australian dollar was "materially overvalued" against the US dollar, but he thought it was unlikely there would be a short-term catalyst for it to revert to more realistic valuations. "All the indicators suggest the Aussie dollar is overvalued against the US dollar, euro and yen. But the question is, when will the factors supporting the Australian dollar rally - commodity prices and/or interest rate differentials - peak? We have a slight tilt against the Aussie, but believe an opportunity to take a more significant short Australian dollar position will arise in 2011," he said.

Bracken and Sneddon are not alone in their views. The majority of local fund managers are showing more interest in growth assets. Even international equities, among the worst-performed asset classes in recent years, are back in favour. Results from Russell Investments' quarterly survey of 35 fund managers found 69 per cent of managers were bullish towards the Australian share market and 67 per cent were bullish towards international equities (up from 41 per cent in the previous quarter).

Only 3 per cent were bearish towards Australian shares, down from 18 per cent in the September quarter. None of the managers surveyed thought the Australian share market was overvalued - only the third time in the survey's history there has been such overwhelming bullish sentiment.

Contrarian investors might consider such overwhelming sentiment a sign to take a more defensive approach. Angus Geddes, chief investment officer at Fat Prophets Funds Management and a resource bull for many years, is moving away from small-cap stocks and including more big-cap financial service companies - a part of the market he has avoided for several years.

"We are taking a barbell approach, with the big diversified miners at one end and the big financials the other, and lightening some small-cap exposure that has done very well for us. We expect the outperformance of small-cap stocks over large caps to unwind in 2011, and have been increasing allocations towards the banks and other big financials that are showing better performance. Long term, we are still great believers in the resource sector, but believe much good news is priced in," Geddes said.

Judging by the response of fund managers, overweight asset allocations towards growth assets are still prominent as the global economy moves from recovery to expansion. However, the growth baton is being passed from emerging markets indices to developed nations, from parts of the resource sector to better-value industrial and resource stocks, and from the small-cap sector to blue chips.

For now the handover seems orderly, but it will not take much for those who ride the risk trade too far to come unstuck in 2011, especially if Chinese inflation expectations rise faster than anticipated. Equally, those funds that hop off the resource trade too early could suffer big underperformance.

After several years of turmoil, having to rotate between several growth assets is at least a new challenge - although the prospect of high volatility makes it as hard as ever to get the timing right.