Recently published data from alternatives asset manager Unlimited shows that U.S hedge funds took a dramatic U-turn on strategy midway through the first quarter of the year, which the firm argues was a direct response to policy uncertainty.
Initial plans for 2025 included pro-growth positions such as long U.S. dollar, and bets on equity and credit spreads, implying a bullish approach to the U.S. economy in general. However, hedge funds inverted this approach in February once it became clear that the Trump administration was going to take a radical approach to economic policy and push an aggressive tariff strategy across the world without consideration for short-term consequences.
The resulting volatility and lack of confidence in the market was in stark contrast to the optimism felt at the start of the year, except in the gold markets, which have proven to be a clear outlier.
“A lot of funds came into the beginning of the year with the projected stance that the new administration was very pro-growth across a number of different dimensions,” said Bob Elliot, CEO of Unlimited. “But when the reality of the administration's priorities became clear it really started to raise questions and damage confidence that a pro-growth view was the predominant dynamic.”
That caused the initial scaling back of positions, and from that point there has been an extreme level of policy volatility that has substantially impacted the markets. “Effectively alpha is decaying in the short term because of the endogenous volatility for any trade. Even if it's a good directional idea, there's just a lot of volatility,” he added.
Volatility has caused hedge funds and other financial firms to take a more defensive stance. Goldman Sachs has a strong outlook bank stocks in light of record revenue from the uptick in trading.
Emerging market hedge funds, with a 6.3 percent average performance gross of fees during the first quarter,, rallied off the back of a buoyant Chinese market. The research from Unlimited, an ETF sponsor that also uses proprietary technology to offer lower cost alternatives, also pointed to the scarce activity in small and mid-cap companies in the U.S. and rising interest in Japanese stocks.
The data suggest that the lack of conviction from hedge funds in the direction of the markets was at its lowest point in the “last couple of decades” and that managers are extremely reluctant to take on short-term bets amid the specter of volatility. While the year started off hesitantly, it did not take long for most managers to pivot to a bearish approach, although the certainty only lasted a matter of weeks before this latest reversal began in earnest. The long dollar positions built out during the immediate post-election optimism were quickly exited, as was the shift in corporate bond spreads – which also moved from long to neutral very quickly. Hedge funds increased their shorts on U.S. bonds, the first such move in several years.
The research was generated using the firm’s machine learning technology to garner aggregated hedge fund positions in near real time from the public reports of around 3,000 firms.
