market folly

Given the recent market downturn and ramp up in volatility, it should come as no surprise that hedge funds have been unwinding risk as of late. Bank of America Merrill Lynch's newest hedge fund monitor report gives us a look at their exposure levels and we see that long/short equity funds have very low net long exposure. However, they have been boosting exposure to inflation plays, growth, and emerging markets. Based on CFTC data, l/s funds reduced gross exposure by selling long positions but also by covering shorts in the S&P 500 and Russell 2000. The majority of longs they sold came from the Nasdaq 100 which would seem to indicate that hedgies were broadly favoring technology names. This would largely coincide with what we've seen from Goldman Sachs' VIP list of stocks that matter most to hedge funds.

Long/short funds are only 18% net long, significantly below the historical average of 35-40%. They are currently favoring growth and high quality stocks, something we've already seen evidence of in our hedge fund portfolio tracking series. And as mentioned above, they've also started to move significantly into emerging markets plays over the course of the last month. Depending on the region, this could possibly tie into the fact that these funds overall have positive inflation expectations. Lastly, we see that l/s funds reduced their already low market exposure a bit more over the past week.

Market neutral funds, on the other hand, are net long equities but have reduced small cap exposure. Surprisingly enough, despite their net long position they managed to escape the month of May largely unscathed. These funds have generally favored value names and have increased that lean over the past few weeks. Market neutral funds also have negative inflation expectations and have been in many 'low quality' names.

Global macro funds bought 10 year treasuries last week and then also aggressively covered their net short US dollar positions. Bank of America Merrill Lynch also points out that these funds have been shorting emerging markets but are still net long the EAFE. This is an interesting dynamic as you have l/s funds ramping up long exposure there and conversely global macro funds increasing short exposure. Lastly, we saw that overall hedgies were covering shorts in the Japanese yen, selling crude oil, and covering crowded shorts in natural gas.

In terms of performance, the month of May was brutal for hedge funds and as a whole they lost 3% throughout the majority of the month. While that may seem tame compared to the market indices, there are definitely some outliers. We saw recently that Shumway Capital Partners' Sakkonet Fund lost around 10%, Eddie Lampert's ESL Investments was down 15%, Chris Hohn's The Children's Investment Fund lost 9% and Andreas Halvorsen's Viking Global was down 4.2%. As evidenced by some of the figures above, it should come as no surprise that long/short equity was the worst performing strategy of the month as funds were overall down 5.13% through the majority of May.

Back in early May, we discovered that global macro funds were net short equities and in the weeks prior to that we saw the smart money was selling equities. So, some funds were definitely able to head off the stampede to the exits. But as you can see from above, some of the carnage was still not pretty. Embedded below is the entire Bank of America Merrill Lynch hedge fund monitor report:



You can download a .pdf copy here.

So, while we definitely signs of funds heading for the exits before this most recent downturn, many hedgies were still blindsided. It's an interesting dynamic when you see hedge fund managers talking about how 2010 will be great for stockpicking and short selling opportunities, yet long/short equity was the worst performing strategy last month. For more on the most important stocks to hedge funds, head to Goldman Sachs VIP list. And to see some of the latest ideas from fund managers, check out the Ira Sohn Investment Conference recap as well as our daily portfolio tracking series.