Hedge funds in pain watching ‘S&P 500 rally’ they’ve missed

Bloomberg

US stocks are vaulting back to all-time highs. But the smart money isn’t celebrating.
Instead, they’re nursing pain. Hedge funds have seen returns dwindling even as the S&P 500 Index marches forward in what has become, by some measures, the longest bull market ever.
An index tracking the performance of funds focusing on equities has fallen in five of the past six weeks, wiping out gains for the year, according to Hedge Fund Research data compiled by Bloomberg.
How is that even possible? Blame it on a defensive stance and bad-luck bets. Net leverage, a measure of risk appetite among hedge funds, has fallen to the lowest level this year. While the posture would have curbed losses during a market selloff, right now it’s prevented managers from reaping bigger gains.
Also hurting are their favourite stocks, notably tech giants such as Facebook Inc. that have suddenly stopped working. Meanwhile, their bearish wagers backfired, with the most-shorted stocks jumping for a third week in four.
“The consensus was that earnings growth will slow down in the second half of the year. That’s why they scaled back from positioning in hopes there will be a downturn,” said Benjamin Lau, chief investment officer of Apriem Advisors in Irvine, California, where the firm oversees more than $700 million. “The momentum for earnings growth, revenue growth is quite strong. Those kind of upside surprises led to some pains.”
The agony is the latest lesson in the costs of turning cautious too early.
While everything from a trade war to emerging-market turmoil threatens the nine-year equity rally, it has still paid to stay bullish with earnings rising the fastest since 2010.
Obviously, the defensive measures could still end up working. Hedge fund clients at Morgan Stanley have reduced their net long exposure to equities to the lowest level since last October. A similar measure from Goldman Sachs on its clients fell to a 14-month low.
The S&P 500 climbed 0.9 percent over past five days to close at a record of 2,874.69. Up in all but one week since June, the index has extended its 2018 gain to 7.5 percent. The Dow Jones Industrial Average added 0.5 percent over the week while the Nasdaq 100 Index advanced 1.5 percent.
With the S&P 500 trading near 21 times earnings, or about 20 percent above its 10-year average, the case for going all-in has weakened, according to Lamar Villere, a portfolio manager who helps oversee about $2 billion at St Denis J Villere & Co. in New Orleans.