Hedge fund positions drop to historic lows in preparation for US presidential election volatility. Hedge funds are selling stocks in the technology, media, and telecommunications sectors to free up funds to deal with market fluctuations. Election uncertainty is causing individual stock divergences to rise, prompting hedge funds to take long and short positions. Traders expect election activities to impact the stock market earlier than usual. Lowering risk is a cautious investment strategy. Hedge fund stock exposures typically decrease before the presidential election
Hedge funds' election trading strategy this year has been: sell out winners' stocks now, free up funds for aggressive buying in autumn, and prepare for the heating up of political competition.
Since May, hedge funds have been doing this, even as the market continues to hit new highs. Data from Goldman Sachs' brokerage division shows that hedge funds' net leverage ratio dropped to 54% in early July, the lowest level since January. After selling the best-performing stocks in the market for two consecutive months, hedge funds have now reduced their holdings in the technology, media, and telecommunications industries to historically low levels.
However, this is not bearish. On the contrary, the so-called "smart money" is preparing for the intense U.S. presidential election campaign, hoping to immediately use funds to place bets when market volatility increases and stock prices start to fluctuate.
Jonathan Caplis, CEO of hedge fund research firm PivotalPath, said, "Managers need to keep enough cash on hand to deal with potential market volatility brought about by the U.S. election. Net selling is just a strategic profit-taking, it's hitting the brakes rather than rushing for the exit."
It is easy to understand why traders are preparing for the volatile election season. Democrats are still looking for a suitable presidential candidate, and calls for President Biden to step down due to his age and health are growing. Meanwhile, the economic agenda proposed by the Republican nominee and former President Trump, including tax cuts, tariff increases, and immigration restrictions, has raised concerns about inflation and the deterioration of the U.S. fiscal situation.
Known events but unknown results will create a trading environment where the differentiation of individual stocks (i.e., the range of potential outcomes when stocks move in different directions) increases. This is good news for hedge funds, as they typically take both long and short positions in their bets.
Given the many uncertainties, some traders expect the election campaign to impact the stock market earlier than usual.
Adam Singleton, Chief Investment Officer of External Alpha under Man Group Plc, said, "What we've heard from hedge funds this year is that the election story may unfold much earlier than November. It is prudent and good portfolio management strategy to reduce risk before uncertain events occur."
Ahead of the presidential election, hedge funds' exposure to stocks usually decreases, and managers quickly reduce leverage shortly before the vote and continue to increase positions after the vote. According to Goldman Sachs' data, the current net exposure is still higher than the long-term average level during the election cycle, indicating there is still room for further selling.
Caplis said, "Often, it's act first and analyze later around these major events."
Hedge funds typically trade political events in several ways. One method is based on industries, where managers identify themes that can benefit from each candidate, reduce exposure before the vote, and then increase exposure to winning themes after the vote Another approach is to measure the overall market risk appetite, which can be seen as a representation of stock price trends. In this case, the foundation first reduces net exposure and then tries to understand how investors view the winners. This wait-and-see strategy worked well in 2016, when the market expected a Trump victory to lead to a stock market decline, but actually rose after Trump's victory.
Finally, the riskiest approach is to focus on specific companies or a small number of stocks, expecting them to perform well or poorly based on who wins. This is the most difficult trade to make, as once the winner is announced, market pricing may experience drastic fluctuations.
Singleton said, "Many managers will try to observe how the situation develops after the election and then take action."
Currently, there is a significant risk for hedge funds that are looking to actively sell off tech giants' stocks that have been driving the market higher over the past year, such as Nvidia, Meta, Amazon, and Google's parent company Alphabet.
Antimo's senior portfolio manager Frank Monkam stated, while this rotation may make sense, ultimately these stock prices should stabilize, but if they continue to defy gravity and rise further in the short term, there may be "squeeze" . In this case, as the expected decline fails to materialize, more investors join the buying, creating a self-fulfilling cycle of rising stock prices.
Ultimately, November trading will determine whether selling the winners was the right decision. Hedge funds can use these returns as they have lagged behind the S&P 500 index for the past four years. According to PivotalPath data, U.S. long-short fundamental hedge funds had a return of only 7.4% in the first half of this year, while the S&P 500 index rose by 14%.
One area where hedge funds have already won is the strong demand for their services. As the election approaches and stock prices near historic highs, investors are becoming increasingly cautious and in need of guidance on how to allocate their portfolios.
Don Steinbrugge, Chairman of global hedge fund consulting and marketing firm Agecroft Partners, said, "Investors are concerned about the valuation of the stock market, and they want to hedge. If they are not concerned, they just need to buy an index fund and hardly pay any fees." He stated that now is the greatest demand for long-short stock fund managers since 2013.