Volatility is back—Here’s what hedge funds are doing during the market’s wild swings

US Top News and Analysis

Volatility has made a comeback, and that’s typically when hedge funds outperform and offer downside protection. Here’s what the smart money is doing during the market chaos. A blowout jobs report on Friday stoked price swings again as investors grew fearful of more rate hikes. The benchmark 10-year Treasury yield jumped in a kneejerk reaction to hover near a 16-year high. Amid the elevated volatility, hedge funds increased their short activity, while focusing on quality stocks, according to Goldman Sachs’ prime brokerage data. The Wall Street firm noticed a pickup in shorting macro-related securities this week. Specifically, hedge funds have been shorting exchange-traded funds in large cap equity, sectors and credit categories for three sessions in a row this week, Goldman said. Macro products are more sensitive to political or economic events, and the increased shorting activity could mean that hedge funds are bracing for more tightening from the Federal Reserve as these securities typically are hurt by rising rates. Quality trade Meanwhile, hedge funds are pivoting to stocks with high-quality fundamentals. Across long-short hedge funds in the U.S., their net exposure to the “profitability” factor is at a one-year high and in the 93rd percentile compared with the past five years, Goldman said. Earlier this week, Goldman’s head of U.S. equity strategy David Kostin advised clients to turn to stocks that are less vulnerable to higher borrowing costs. The strategist expects the higher-for-longer interest rate regime poses a direct threat to company profitability. The firm screened the S & P 500 for stocks with low leverage, high interest coverage and low EBITDA growth variability. Costco , Cisco and Cadence Design Systems were some of the stocks recommended. Underweight cyclicals Hedge funds have been moving away from cyclical stocks — those that ebb and flow with the strength and weakness of the broader U.S. economy. The cohort lowered their weighting in cyclical stocks over the past month, now underweight by 14.5%, the most since January, according to Jefferies equity strategist Steven DeSanctis. Economically sensitive stocks could particularly feel the pain from an economic slowdown and possible U.S. recession as the Fed stands up its tight monetary policy. The real estate sector, for example, saw a net short position of 2% among hedge funds, DeSanctis said. — CNBC’s Michael Bloom contributed reporting.