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Hedge funds navigated the difficult 2022 market environment by maintaining low risk and conservative positioning across assets. An index of industry returns ended 2022 at -3% gross of fees for the year, compared with S&P500 returns of -18% and broad bond market returns of -13%.
Hedge funds start 2023 with a similar stance. Equity and bond risk remains low and risk taking, on a volatility-adjusted basis, is near all-time lows outside of crisis periods. Hedge funds see the best opportunities across credit and in smaller companies outside the headline indexes. And funds hold their biggest underweight positions in growth stocks in decades, particularly in tech names. Put together, these funds show there is opportunity to take prudent risk across certain sectors and assets, but it’s not a moment to be leveraging up.
Scanning across positions in aggregate shows that hedge funds are running low stock and bond risk relative to their longer-term averages and are running above-normal risk in credit positions. Positions in commodities, while small, are being rebuilt, and funds remain modestly short the dollar.
Today’s equity market positioning is very unusual - heavily tilted to holding smaller companies than in the S&P500 and a strong inclination against traditional growth sectors.
Hedge funds have been underweight tech stocks over the past year, but in recent months have meaningfully increased the size of their short positioning. At this point, funds are the shortest they have been since the tech bust.
Funds are seeing the best opportunities in the credit markets in the highest credit quality areas. Senior bank loans and mortgage spreads are sources of the largest overweights while they hold more average positions across bond markets with credit risk. It is another indication of the desire to have some risk while remaining conservative.
Hedge funds typically outperform during difficult market environments and 2022 was another example. The way they do it is by maintaining modest risk and looking for incremental opportunities across assets. So far, 2023 looks like more of the same prudent tactical management.