I spent what might very fairly be described as an inordinate amount of time in these pages writing breathlessly about hedge fund de-netting and de-grossing in October, as the bottom fell out for market darlings and various consensus longs.
When it comes to assigning blame for October, you can probably point to the rather noxious combination of Jerome Powell’s “long way from neutral” remark, Donald Trump’s “greatest tariffs” and midterm election jitters as the proximate cause.
But when it comes to what served as gas on the fire, you might well cite the early-month bond rout, option hedging dynamics and systematic de-risking on October 10 and also the trials and tribulations of equity funds, which were crushed by violent Growth-to-Value rotations and dramatic Momentum unwinds.
Hedge funds had a rough go of it in October and while there are innumerable ways to slice and dice that universe, it was pretty bleak for most folks. The HFRI Fund Weighted Composite Index had its worst month since 2011, just to recap things at a 30,000 foot level.
Meanwhile, the HFRI Equity Hedge Total index dove a truly harrowing 4.5%, its worst month since January 2016, a time when things weren’t going well, which kind of underscores what kind of environment we suddenly entered last month.
Anyway, the point is, it was a rough month for hedge funds, especially of the equity variety and the poor performance had everyone on edge for redemption “D-day” last week.
With all of that as the backdrop, Goldman is out with the latest installment of their hedge fund trend monitor and, consistent with what folks suggested during October, the bank’s high frequency data (so, what they get from their prime desk) shows net and gross exposure falling to the lowest levels since the first half of 2017.
That’s a continuation of the trend, but Goldman notes that it appears to have accelerated recently which makes sense because, well, because just think about what’s happened over the past two months.
“Hedge fund net exposures have steadily declined throughout 2018, including during 2Q and 3Q while the broad equity market rallied”, the bank writes, before elaborating as follows:
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 our colleagues in Goldman Sachs Prime Services show a similar picture, with net leverage peaking in January 2018 and declining steadily since.
While net exposures have declined all year, gross exposures remained elevated until the recent equity drawdown. Gross exposures have declined sharply since the S&P 500 turned lower in early October.
So that’s the “smart” money which, as noted, was de-netting/de-grossing even as the market rallied this year off the February lows.
The “dumb” money, on the other hand, was not paring their exposure during the push to new highs. In fact, according to cash as a % of client assets in Charles Schwab accounts, retail investors were all-in by the end of September, with cash balances falling to a record low of 10.3%.
And then came October.
According to the latest monthly activity report dated November 14, Schwab’s clients raised cash (i.e., ran screaming to the sidelines) at the fastest pace since 2015 last month, when cash as a % of assets jumped to 11.1%. Have a look at this:
On the bright side, at least “cash” actually yields something these days.
And so, with both the “dumb” money and the “smart” money having pared their exposure materially, I suppose the only remaining question is whether discretionary/fundamental investors are too shellshocked to buy the dip.
If they are, you can hardly blame them. After all, buy-the-dip stopped working in 2018 for the first time in 16 years.