Hedge Funds Fretting U.S. Stock Doom Have Nimble Counter-Plan
Bloomberg – Hedge funds are snubbing broad bets on the stock melt-up and shifting to market-neutral strategies, according to Nomura Holdings Inc., underscoring the skepticism dogging this gravity-defying bull run.
Fast-money exposure to U.S. equities has plunged to the lowest since 2013, according to an estimate of the portion of their returns attributable to the S&P 500 Index. Other data show the ratio of bullish bets to bearish ones near the lowest in more than a year.
It’s a sign that hedge funds remain steadfast in their refusal to chase the rising market as they opt for nimbler trades — rather than a warning that the smart money is aggressively selling into the rally, according to quantitative strategist Masanari Takada.
Hedge funds may be putting on more market-neutral strategies like long-short positions or mean-reversion trades, which would give them less exposure to overall benchmark moves, said Takada.
“Given an uncertainty on the market itself, most hedge funds might be less convinced to take overall market risk proactively,” the strategist wrote in an email.
For instance, managers are likely buying low-volatility names and shorting high-vol stocks, or betting on defensives and selling cyclicals — all trades that would cap their exposure to swings in the S&P 500.
“I doubt that the funds have been selling equity massively given the market itself keeps rallying,” he wrote.
Other reasons for their low overall exposure to U.S. stocks may be that they’re slashing leverage, adding hedges, allocating more to cash, government bonds and derivatives, or scrapping trend-following strategies, according to Takada.
It’s another way of thinking about the conspicuous absence of fast-money traders in the melt-up that’s powered a 23 percent return for U.S. stocks since Christmas.
Some of the rally’s other putative deficiencies — its speed and the fact that barometers like small caps and transports are lagging — are starting to look like strengths to those with a glass-half-full disposition. The stubborn refusal of investors of many stripes to participate gives fuel to bears and bulls alike.
Others such as risk-parity funds, which adjust their asset allocations based on price swings, have slowed their equity buying, according to Nomura. Commodity trading advisers — trend-following quants — will likely stay on the sidelines until the S&P 500 is safely above 2,900, a level the index breached today for the first time since October.
The picture is similar beyond hedge funds. About $90 billion has left equity funds this year, including $2.6 billion of outflows in the week through April 10, according to a Bank of America Corp. report that cited EPFR Global data.
While Bank of America remains bullish, investors have been “twitchy” as the dovish Fed, a U.S.-China trade deal and signs of a global recovery have all been largely discounted, strategists led by Michael Hartnett wrote in a note.