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Equity Hedge Funds Are Riding the Bullish Wave Sweeping Bonds

Equity Hedge Funds Are Riding the Bullish Wave Sweeping Bonds

(Bloomberg) -- Wall Street has been sounding alarm bells all year over swelling valuations and overcrowding in stocks tracking the fortunes of government bonds. The smart money kept the faith, and it’s paying off.

Equity hedge funds have gained 7% in 2019 as exposure to the momentum factor -- which buys the winners and dumps the losers over the past 12 months -- jumps to the highest in two years, according to Sanford C. Bernstein citing Hedge Fund Research.

It looks like the ferocious bull run in debt markets has something to do with it.

A long-short Bloomberg-compiled portfolio tracking the momentum strategy has risen 11 straight days through Wednesday, the longest streak in at least 19 years. At the same time, key longer-maturity bond yields in America and Europe have plunged to all-time lows.

It all suggests that hedge-fund portfolios are stuffed with equities that move to the bond-market beat.

Equity Hedge Funds Are Riding the Bullish Wave Sweeping Bonds

“Hedge funds have been on the right side of falling yields,” Bernstein strategists led by Sarah McCarthy wrote in a note.

Bond proxies like real estate and utilities have surged all year as investors hedge the risk of a downturn with defensive firms that dangle dividends or low volatility. That’s given equity funds a bond-like tilt. While Bernstein remains neutral on momentum, it notes valuations are “very stretched” versus the norm.

Hedge funds “may want to become more wary of this increased exposure to momentum,” the strategists said.

The investing style comes in different shapes and sizes tracking all manner of models. But using the time-frame commonly used to construct the factor, the last 12 months excluding the most recent month, utilities and real estate have been the top performers in the S&P 500 -- sectors that acutely benefit from low yields.

The two biggest losers, materials and energy, are sensitive to darkening economic expectations as flashed by the global charge into government debt.

Equity Hedge Funds Are Riding the Bullish Wave Sweeping Bonds

A Societe Generale SA index for a trend-following strategy in interest rates has also surged to a record this week. Another gauge tracking commodity trading advisers’ overall performance has extended an 18-month high.

Yet not all types of hedge funds appear to have harvested broad gains thanks to bonds. Among equity quantitative managers, performance is still down 1% in 2019, according to Bernstein.

Equity Hedge Funds Are Riding the Bullish Wave Sweeping Bonds

The team at Macro Risk Advisors has also noted the performance of momentum amid the rush into bonds. There’s a near-perfect correlation between the factor and another known as anti-beta, which buys steady equities and sells volatile ones, strategist Maxwell Grinacoff wrote in a note last week.

“Investors have been piling into lower-beta defensive, ‘bond-proxy’ type stocks that typically offer higher dividend yields than government or corporate bonds,” he said.

Equity Hedge Funds Are Riding the Bullish Wave Sweeping Bonds

In a rotation, utilities would be most at risk of a sell-off, given the sector’s high correlation to both momentum and anti-beta, Grinacoff wrote.

To contact the reporter on this story: Justina Lee in London at jlee1489@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Sid Verma, Samuel Potter

©2019 Bloomberg L.P.