Hedge funds started increasing their equity position in the second quarter, as stock valuations began stabilizing after last year’s sell-off. Buying increased dramatically into the third quarter when, according to the report, net exposure jumped 130% to $95 billion. Their favorite sectors include large cap growth and technology, but have also increased their positions in defensive areas such as Health Care and Consumer Staples. And as a group, hedge funds have moved from a net short to a net long position in Financials.
Following hedge fund activity in the capital markets can yield valuable insight on the capital markets. As a group, these private investment partnerships have become increasingly important as market participants. At present, hedge funds hold approximately 4% of the total U.S. equity markets, and are responsible for the bulk of equity positions held short. Further, there is evidence that hedge funds have stock-picking skills that are far superior to those of actively managed mutual funds or private investors. The so-called “HF Generals,” the list of the most popular stocks among hedge funds compiled each quarter (based on 13F filings) is up 62% year-to-date and has outperformed the S&P 500 by 41% in 2009.
The trend of increasing equity ownership also illustrates the tremendous amount of cash waiting on the sidelines. As more investors revisit the stock market, valuations will likely continue to improve. One must take caution, however, not to be the last one at the party. If the much heralded economic recovery fails to take hold in the next few quarters, equities could likely retreat.