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Hedge funds go defensive, mutuals dump stocks. And it's all good.

Summary: Reasoning is based on a well-established fear dogging bull market: crowding

Dani Burger, Bloomberg


Active fund managers in the US and Europe have slashed their equity holdings -- giving some Wall Street players confidence stocks have further room to run.

That may sound counter-intuitive at first. But the reasoning is based on a well-established fear dogging this long-lived bull market: crowding, or the risk the investing herd will exacerbate sell-offs when volatility erupts.

With fast money getting defensive and mutual funds curbing stock allocations, the firepower of both groups to fuel bearish moves is now more limited. It's potentially a protective buffer at an opportune time, as volatility plumbs post-February lows and prompts warnings of a breakout on the heels of any trade war.

"The relatively lower levels of sentiment and the reduction in risk levels looks like it has probably removed at least one risk both to the market and to the performance of active managers," Sanford C. Bernstein & Co. quantitative strategists led by Inigo Fraser-Jenkins wrote in a note. "It is enough for us to be happy to continue with our pro-cyclical stance."

Equity long-short hedge funds, for their part, have been tilting their holdings to less economically sensitive industries over the past month. The ratio of cyclical to defensive exposure is hovering just above a one-year low, according to Credit Suisse Group AG prime services data.

Hedge funds are now "certainly more defensive than global growth and GDP estimates would imply," said Mark Connors, head of risk advisory at the Swiss bank.

Meanwhile, the broader market is accounting for less of the returns posted by publicly-listed US and European funds. That measure known as beta demonstrates managers have deliberately de-risked, according to data compiled by Bernstein.

Investors may infer a bearish signal about the macro climate in all this, of course. But the light positioning could be a tactical play.

Managers may feel less confident leaving large positions on around this time of year, according to Colin McLean, co-founder of SVM Asset Management Ltd.

"There may be a bit of window dressing before the summer," said McLean. "Liquidity is a bit lower so often fund managers will try to cut risk and harvest a bit of profit."

The analysts at Bernstein place the blame on heightened stock correlations over the past six months, which hover near their highest since 2016 for the S&P 500 and Euro Stoxx 50, respectively.

While that's not so dramatic, the stock-picking environment remains less favourable than last year, so it "may make sense for fund managers to decrease active risk somewhat," Fraser-Jenkins and team wrote.

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Publication:Gulf News (United Arab Emirates)
Date:Jul 21, 2018
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