After a slight improvement in hedge fund (HF) performance yesterday and a positive outlook today, here are the latest observations from JPMorgan

Overview:

HF performance began to bounce back on Tuesday, driven by better momentum and less crowding.

However, HF crowding has experienced significant declines over the past month, approaching some of the lowest levels witnessed in recent years in North America and EMEA. This trend may indicate that much of the adjustment could be concluded.

Nonetheless, gross flows have not reflected a similarly extreme shift, aside from a substantial 1-week de-grossing in EMEA. Gross leverage continues to be high but is beginning to decrease. Therefore, potential risks could arise if we either keep selling off (impacting long/short funds that haven't significantly cut back their long exposure) or if there is a swift recovery (which could affect quants who have increased their gross flow to meet target leverage, but may need to reverse course quickly if the markets rebound sharply, particularly if driven by shorts).

The most favorable scenario may be a gradual rebound in market and HF performance accompanied by reduced volatility that permits further risk recalibrations.

From a net standpoint, CTA net risk in US equities has returned to levels not seen since October 2023, although it remains above the lows observed in 2022. A significant portion of the net selling appears to be occurring in futures. HF net flows in North American stocks were more negative from late January to mid-February but have been more positive recently, with some buying in Mag7 and large-cap software as well as covering shorts in large-cap healthcare, staples, and utilities, while stocks in airlines, energy, banks, and medical technology faced selling pressure. Retail and ETF flows have varied but haven’t shown significant selling trends.

In general, the recent net flows suggest modest selling and hedging of risk without indications of extreme capitulation. The aggregate positioning level of our TPM remains quite low over a 12-month period (around -2z) and slightly below average since 2015 (-0.4z or 25th-30th percentile). Europe has encountered very challenging alpha over the past week, coinciding with one of the largest 5-day de-grossing periods in several years (-2.6z).

Long positions in capital goods, UK exporters, financials, and healthcare have been sold, while shorts primarily covered in consumer and retail sectors. From a net perspective, recent flows among HFs have been somewhat negative, and we do not observe the relative HF flows between the US and EU continuing to reflect the ongoing EU outperformance. Among CTAs, the relative positioning of EU versus US equity is at its highest since the first half of 2023, with movements resembling early 2022 when US equities declined faster than EU. Momentum risk remains high.

In Asia, HF performance has been more resilient, with minimal de-grossing observed. CTAs maintain a significantly net long position in Hong Kong stocks (approaching historical highs), while HFs have recently been selling Hong Kong stocks through new short positions. Japan continues to experience net selling, consistent with its year-to-date trend. HF net positioning in Hong Kong stocks remains somewhat elevated compared to past years (long/short ratio in the 71st percentile and net exposure of +1z), albeit showing signs of slight decline. Japan’s positioning mirrors Hong Kong’s compared to longer-term data, although the trend has been consistently negative over the last few months.