Market Surges At Worst Possible Time For Hedge Funds
Two weeks ago, when looking at the latest hedge fund 13-F reports (for Q3) Goldman found two remarkable, if perhaps expected, things: following the summer rout in some beloved tech names such as Facebook, the 2 and 20 (more like 0.5% and 5% these days) industry had retrenched and hunkered down, and as a result, hedge fund net exposures had steadily declined throughout 2018, including during 2Q and 3Q while the broad equity market rallied. Net long exposure calculated based on 13-F filings and publicly-available short interest data registered 49% at the start of 4Q, a decline from 56% at the start of 2018. Data calculated by Goldman Sachs Prime Services showed a similar picture, with net leverage peaking in January 2018 and declining steadily since.
We also showed that while net exposures declined all year as a result of adding more shorts – most of which ended up blowing up at every bottom resulting in furious short squeezes that only detracted from overall performance – gross exposures remained elevated until the recent equity drawdown. In fact, according to Goldman data, gross exposures only declined sharply since the S&P 500 turned lower in early October.
Which of course was bad news for hedge funds last Wednesday, when the S&P exploded higher after Fed Chair Powell appeared to throw in the towel on the Fed’s hawkish stance, stating that the Fed Funds rate is “just below” the (range) of the neutral rate of interest. Powell’s soundbite sent markets soaring, however with shorts once again outperforming net longs, hedge funds were hammered as not only did they not capture any of the (shrunk) beta, but they were once again skewered by their hedges as everyone rushed to cover en masse.
The same collapse in net hedge fund exposure was even worse news for the smart money today.
As Nomura’s Charlie McElligott writes “ad nauseum”, the equities “gap higher” is the trade which hurts the buyside the most — and now after this latest can-kicking tri-party (Powell, Trump, Xi) “blink,” insult is further added to injury.
The reason is a familiar one: as the cross-asset strategist explains, “there simply is not enough “net (long) exposure” on for HFs to realize any of this Equities rally”, while mutual funds instead used last week’s rally to further “de-beta” portfolios (which is “the right thing to do” at this point in the cycle!), as Nomura’s measure of US Mutual Fund “Beta to SPX” shows an absolute nuking down to 17th %ile last week (from 57th %ile the week prior).
Meanwhile, Macro Funds took the other side of the trade, perhaps “sensing this risk last week” and increased their “Beta to SPX” to 31st %ile (from 8th %ile—was 61st %ile 1m ago) as well as their “Beta to Nikkei” to 58th %ile (from 32nd %ile, was 75th %ile 1m ago). And as McElligott previously discussed, systematic CTA funds “will be FORCED / PRICE-INSENSITIVE BUYERS due to this “gap” in SPX, RTY, NDX, SX5E, NKY, DAX, FTSE and nearing “buy levels” in CAC, HSI, HSCEI and AS51 (“long” buying in US Eq and NKY, “covers” in the others)—SPX today likely sees a notional buy of +$18.6B.” Unless of course stocks were to close in the red…
Adding even more insult to injury – or rather today’s sharp market spike higher – Nomura observes that there was a “brutal” sector / factor de-disking rotation occurring as well, with ALL funds purging their “Beta” (Beta M/N -18.1% between the start Oct into the start of the last week Nov).
Stated simply, funds were getting “Defensive” and selling High Beta against buying Low Vol—thus we see Utes, Staples and REITS as the only positive S&P sectors QTD, against Materials -6.1% / Comm Services -6.7% / Industrials -7.8% / Cons Disc -9.0% / Tech -10.0% / Energy -13.3%.
So as a result of the ongoing performance struggles over the past two months, “and the psyche damage” many funds had “battened down the hatches” into year-end, with very few willing to “pay away” already negative performance despite the risks of an upside move into YE as vol in general was so expensive.
Thus completely failing to “capture” both Wednesday’s and today’s gap.
What is odd is that last week’s futures positioning update (through last Tuesday) showed the beginnings of a “dynamic hedging” spasm: Leveraged Funds added +$3.4B in SPX, NDX +$1.3B, +$700mm in RTY, while Asset Managers bot +$1.5B in SPX, +$600mm in EM Equities…and it goes without saying that those number REALLY jumped later in the week.
Indeed, in the hedge funds’ attempt to capture beta, equity ETFs saw +$11bn inflows on Wednesday, the largest 1-day inflow since June 12th outside of expiry/rebal week. Inflows to equity ETFs exceeded $20bn from Tuesday through Thursday across pseudo-futures, asset allocation, and sector products.
And yet despite all these positioning scrambles and attempts to capture beta upside, it is the shorts which continue to outperform the market…
… not only resulting in another day of negative P&L, but further demoralizing a sector which no matter what, can’t seem to generate any alpha in 2018.
Ironically, the only thing that could save hedge fund performance today is if the market closed… in the red.