Hedge Funds Shift Strategies Amid Market Rebound and Record Highs

Hedge Funds Shift Strategies Amid Market Rebound and Record Highs 

Last weekend, we reported that according to Goldman's Prime Desk, as stocks continued their rebound from the post-August slump, hedge funds, who had turned very bearish before the late-July downturn and then briefly became bullish, resumed selling and shorting stocks. A week later, the trend continued, with Goldman's Prime Brokerage reporting that as the market extended its gains and reached new record highs after Powell's dovish speech at the Jackson Hole conference, hedge funds, excluding CTAs, started fading the rally once again.

Equity markets have experienced an impressive rally over the past two weeks, with the MSCI Total Return Index up by 8.3 percent since August 5th. This rally has been driven by a combination of factors, including a reduction in growth concerns and recession odds, a sharp reversal in volatility trends, and a shift in flows from CTAs and rules-based funds from being a headwind to a tailwind. In this environment, Fundamental Long/Short returns have recovered, gaining 0.6 percent so far in August, after being down as much as 3.8 percent earlier in the month, and are now up 8.8 percent year-to-date.

Despite the market's rebound, Gross and Net leverage ratios have decreased in August, indicating that there has been little recovery in risk appetite following the significant de-risking that occurred in July. From a flow perspective, hedge funds are on track to be net sellers of global equities at the fastest pace since March 2022, driven by short sales in the U.S. and long sales in other regions. Both Single Stocks and Macro Products have seen net selling this month.

In North America, short sales have made it the most heavily net sold region so far this month. European stocks have been modestly net sold, primarily through long sales, while short flows have remained muted after significant covering in July. Developed Markets Asia is the second most net sold region, led by Japan, which has experienced the largest 10-day cumulative net selling in over five years. Emerging Markets have also seen substantial risk unwinds, particularly through long sales in China, South Korea, and Taiwan.

In the U.S., hedge funds have been selling Large Cap stocks this month, while buying Small Caps. The Information Technology sector is the most net sold, on track to be net sold for the fourth consecutive month, driven by short positions in Semiconductors and Semiconductor Equipment, partially offset by long buys in Software. The sector's Long/Short ratio is now near five-year lows. Consumer stocks have seen significant de-risking this month, driven by long sales in Discretionary and short covering in Staples. In a lower interest rate environment, managers appear to be favoring high dividend stocks, with Energy, Utilities, and Real Estate, the sectors with the highest dividend yields, among the most net bought this month. Energy is the most net bought U.S. sector in August, driven by long buys, and has been net bought in eight of the past nine weeks. Net allocation in U.S. Energy stocks is at its highest level year-to-date and ranks in the 65th percentile over a five-year period.

After declining through June and July, hedge funds' Momentum exposure has stabilized in August and is now roughly in line with one-year and five-year averages. Factor exposure to Growth has increased this month, though it remains well below its year-to-date high. After pulling back in July, Fundamental Long/Short returns from Long Crowdedness have seen strong gains in August, partly offset by losses from Short Crowdedness.

At the individual stock level, hedge funds appear to be showing renewed interest in Small Cap stocks after selling during the group's rally in July.