HEDGE FUND EQUITY EXPOSURE

(via Carpenter Analytix)

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REPORTING DELAYS:

One week

EXPLANATION:

Hedge funds, particularly managed futures (CTA) funds are aggressive investors and traders.  They go long or short, and they cross asset classes readily.

Most important, they are consistent trend-followers.  When trend-following goes too far - gets overdone - the contrarian principles come into play.  Research shows that when CTA funds go to extreme exposures in aggregate, a trend reversal is getting near.

Carpenter Analytix tracks CTA fund exposures via analysis of their returns streams.  Like any portfolio, hedge fund returns "behave" statistically like the behavior of their component parts.  In tracking the evolving returns behavior, we reverse-engineer the stats to see what kinds of components are driving the returns.

GUIDELINES:

We treat this data as we do most sentiment indicators, which is in a contrary fashion.  While hedge funds are supposedly the "smart money", and undoubtedly many of them are on an individual level, when considered in aggregate they work like any other large group.

Because of that tendency, we want to look for extremes in the exposure data.  When fund managers are extremely net long, we want to be on the lookout for a market correction, since hedge funds would be one less source of potential buying power if they're already heavily exposed.

When fund managers are not very invested on the long side, or particularly if they are net short, then we should be on the lookout for a market rally.  Funds are an excellent source of "short covering" stampedes when they're exposed to the short side and the market starts to rally, so when they are in that position, we should be careful about being too aggressive on the short side ourselves.

While the bear-market history of this data is limited, we should be aware that hedge funds were net short for all of the 2000 - 2002 time period.  While that seems "smart" on their part, and it was, we should look at the data on a relative basis.  Funds were their least net short near market peaks during that time, and their most net short near intermediate-term lows.  That's not very smart, and why we still consider this to be a contrary indicator.

You may notice that the indicator goes "off the chart" to the downside in September 2001.  Due to the difficulty of obtaining reliable pricing data around the 9/11 tragedy, the indicator values around that time may be somewhat compromised.  Because of that, we truncated the chart around that time so that it does not meaningfully skew the other data points.

ADDITIONAL RESOURCES:

Carpenter Analytix (www.CarpenterAnalytix.com)