Hedge funds retrench on risk, fearful of increased volatility

Commodity-Trading Advisors and Hedge Fund Strategies Amid Market Uncertainty

Commodity-trading advisors (CTAs), or money managers who follow market trends, have registered a “sharp unwind” of long equity positions, short yen, and short Japanese and 10-year German bonds. This shift began following the release of weaker-than-expected U.S. job data on August 2, as noted by JPMorgan in a recent report.

In a related development, Goldman Sachs’ prime brokerage issued a note to clients indicating that long/short equity hedge funds reduced their overall exposure to Japan from 5.6% to 4.8% last week. These funds also cut their overall portfolio leverage by nearly one percentage point, bringing it down to 188.2%.

Moreover, data released on Friday by the U.S. Commodity Futures Trading Commission and LSEG showed that hedge funds have scaled back their positions on the Japanese yen, resulting in the smallest net short stance since February 2023. This indicates a winding down of the yen carry trade.

Macro Concerns and Portfolio Adjustments

Concerns over the U.S. economy are now front and center for portfolio managers, contributing to the de-risking of portfolios. Fears of a recession in the world’s largest economy have escalated following a rise in the U.S. unemployment rate in July.

Edoardo Rulli, Chief Investment Officer at UBS Hedge Fund Solutions, mentioned that while macro hedge funds have profited from the market rout by being long on U.S. rates, they are now reconsidering some positions. “Macro hedge funds still have conviction around the steepening of the yield curve, but they are taking some profits because obviously it’s done very well over the past four weeks,” Rulli said.

The odds of the Federal Reserve cutting rates by either 25 basis points or 50 basis points at its next meeting in September are currently close to even, according to the CME FedWatch tool as of August 12.

Richard Lightburn, Deputy Chief Investment Officer at macro hedge fund MKP Capital Management, emphasized the uncertainty in the market. “If there is a 50/50 chance between the Fed cutting 25 basis points and cutting 50 basis points, that is maximum uncertainty,” Lightburn noted. He is considering potential adjustments to his portfolio to better reflect the unpredictable environment. “That’s telling you something – the market really doesn’t know what’s going to happen, and that means there’s going to be volatility,” he added.