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.

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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.

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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 nauseam", the equities "gap higher" is the trade which hurts the buy side the most — and now after this latest can-kicking tri-party (Powell, Trump, Xi) “blink,” insult is further added to injury.

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