Hedge Funds Staying Defensive As Equities Creep Higher


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It’s been a difficult year for the Hedge Fund industry, generating mid single digit returns in an environment of very strong equity performance. Despite pressures to catch up, the industry remains conservatively positioned.

While equity allocations are back closer to normal, they are tilted away from growth stocks to those stocks and geographies with lower valuations. Credit exposures that are being taken are of higher quality credits. Funds are also underweight bonds, which is consistent with an expectation of higher rates to come. The result is a portfolio that remains defensively positioned against further Fed tightening while remaining in the market to pick up some gains if they come.

The chart below shows how hedge fund managers are positioned across the major asset classes relative to their long-term averages.  While equity and credit allocations are tilted long, bond allocations are notably underweight.

Current Hedge Fund Asset Class Positioning

 

The overall neutral equity position obfuscates some relatively big diffs. Funds remain positioned against US, megacap, and tech.

Current Hedge Fun Equity Positioning

 

Funds are significantly overweight mortgage credit risk (agency) relative to history.

Current Hedge Fund Credit Positioning

 

Managers may be positioning to take advantage of spreads in these products remaining at historical extremes – almost 3 percent higher than the prevailing 10-year bond and much higher than nearly any time in 20 years.

Yields via Fred

 

While funds have underperformed equity markets since the start of the year, these funds are not racing to catch up by leveraging up.  Risk taking on their overall portfolios remains at roughly the long-term average.

Hedge Fund VAR Estimate

 

Many think that hedge funds are high volatility vehicles focused on generating outsized returns vs. equities. While some managers work that way, most are conservative and prudent stewards of capital trying to generate stock-like returns at lower risk. This makes them almost boring in aggregate when that strategy works as intended.

A lens a little wider than the first half of 2023 shows that funds have done just that over the last few years. That more conservative approach delivers two related outcomes – limiting drawdowns and not chasing returns. Over time, this approach has worked well and because of that investors should take the recent conservative approach as a sign of Hedge Funds sticking to their gameplan that works over time rather than an indication of falling behind.

 

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