The current slump is clearly not your garden variety stock market correction. Not only is the volatility extremely high, with global markets following each other up and down like yo yos, but some of the usual suspects on Wall Street are not de-risking as has become the norm during significant corrections over the past several years.
Who knows what it all means, but if hedge funds are not taking their bets off the table, they obviously think there’s going to be a substantial rally when the selling is done.
In a report published on August 28th, Credit Suisse analyst Mark Connors offers an overview of the situation: “In a stark departure from previous periods of Risk-off, managers reacted to the mid-august market rout by INCREASING gross exposure on market adjusted basis, leading with selective long purchases instead of deleveraging with a tilt to the short side as we saw in March 2014, October 2014 and January 2015. Underscoring the bullish stance is the more recent reduction in Gross, led by short covering over the past several days.”
Hedge funds keeping the faith for future stock market rally
The CS report notes that equity long/short, event driven and quant funds all boosted their net exposure both during and after the market sell off two weeks ago, adding to commonly held long positions.
Connors says: “Since the credit crisis, we have NEVER seen hedge funds ADD to Net and Gross exposure during such a material risk-off move. As the chart for Equity Long/Short funds below illustrates, the elevated Equity L/S ratio (blue line) at 56% stands in stark contrast to the market sell-off (grey) and other risk off periods such as March 2014, Oct 2014 and Jan 2015, when managers de-risked, bringing the ELS ratio to as low as 40%.”
Hedge fund position changes last week by fund type
It appears that event driven funds saw the biggest increase increase in gross positions, buying index shorts as hedges against long positions as deal spreads widen and the prices of special situation or distressed firms are slashed.
Of note, it turns out equity L/S funds actually added more long exposure in the already overweight (and recent poorly performing) Internet Retail segment.
The CS report highlights that hedge funds aggressively covered precious metals from -22% overall to net long by the end of last week as the probability of a Fed hike dropped and market risk moved up. Of interest, energy short remain quite close to all time low at -14%.
Finally, macro/CTA funds have not changed their bearish outlook, and continued to cut back on net exposure when opportunities presented.