Equity hedge funds cut risk in portfolios, less confidence in rallies

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NEW YORK, Oct 31 (Reuters) – U.S. equity long/short hedge funds have cut to six-year lows the level at which swings in the S&P 500 (.SPX) affect their profits or losses, as portfolio managers are taking less directional bets, data from hedge fund research firm PivotalPath showed.

Hedge funds are increasingly adopting a more defensive strategy as concerns about the macroeconomic environment have made making directional bets on the stock market harder, PivotalPath said.

“The notion that rates will stay higher for longer is much more accepted today than when the Federal Reserve was continuously hiking in late 2021/2022,” PivotalPath Chief Executive Officer Jon Caplis. “While these higher rates haven’t necessarily been fully discounted into lower valuations, they have generally decreased confidence.”

A stock rally concentrated in a few sectors – such as mega-cap tech companies – has not generated the usual spike in confidence surrounding broader rallies, he added.

The so-called fundamental long/short hedge funds strategy exposure to the S&P fell in September to its lowest level for the rolling 12 months since 2017, PivotalPath said. The data firm tracks $3 trillion in global hedge funds.

The funds’ beta, or the volatility of its returns in comparison to the S&P, amounts currently to 0.3, versus a historical mean since 2008 of 0.43. A higher beta denotes more sensitivity.

This more neutral positioning has translated into lower gains for hedge funds this year. Fundamental equity long/short hedge funds focused on the U.S. are up 8.2% this year through September, according to PivotalPath, below the S&P 500 return of almost 12% in the first nine months of the year.

Banks see a similar trend in terms of exposure in their clients’ books. JPMorgan Chase said in a recent note the lack of conviction among investors is quite “palatable,” listing a challenging macroeconomic environment and the geopolitical backdrop as reasons, as well as poor performance of long positions.

Last week, hedge funds cut net leverage – a gauge of risk appetite measured by the difference between long and short positions – to a level very close to a record in the last 10 years, a Morgan Stanley prime brokerage obtained by Reuters showed.

Jim Neumann, chief investment officer at hedge fund advisory firm Sussex Partners, said he has seen several rounds of de-risking, but funds “are not performing particularly well.”

“My guess is that managers would like a strong year-end but will only jump on if the ‘Santa Claus’ rally seems to have legs. They cannot afford to get whipsawed and drawdown given the mediocre performance in 2023,” he added.

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