The latest report released by Bank of America Merrill Lynch (BAML)’s Hedge Fund monitor presents interesting insight into how asset flows in hedge funds are determining their market exposure. This directly opposes the belief that hedge funds decide their positions according to  how they perceive the market is behaving. The present asset flows can prevent hedge funds from raising market exposure till the year’s end, as asset outflows have outnumbered the amount of inflows.  In order to achieve more exposure, the assets under management have to be turned up by hedge funds, but the chances of that happening are minimal in the coming quarters.

BAML’s analysis indicates that Equity L/S funds are holding market exposure at 24 percent, which is below the 35-40 percent threshold. This exposure has been below average for a quite a number of months now. Data from previous years indicates that the trends in asset movements has correlated with the market exposure of L/S hedge funds since 2004. According to BAML’s calculations, 60 percent of the variations in the Long vs Short  positioning can be determined by asset flows and this could serve as a contrarian market indicator as a good buying opportunity.

LS market exposure relation with AUM

In the first week of November, the Investable Hedge Fund Composite Index outperformed the  S&P 500 (INDEXSP:.INX), with +0.10 vs -1.25 percent. The year to date numbers indicate that IHFC index has gained the most for Convertible Arbitrage (5.66 percent), Event Driven (3.84 percent), and Equity L/S (3.74 percent). The equity Market Neutral index has contracted by 5.48 percent in this year. Large spec hedge funds continue to buy S&P 500, NASDAQ-100 (INDEXNASDAQ:NDX), 10 yr notes, crude, sold heating oil, gasoline, and USD. Gold, silver, platinum, soybeans were reduced, while shorts in Euro and JPY were increased.