Hedge Funds Cut Long Exposure as Short Bets Drive Losses, Goldman Sachs Data Shows

Hedge funds reduced their long equity positions and de-risked portfolios last week after bearish bets backfired and drove significant losses, according to a report from Goldman Sachs’s prime brokerage desk. The data indicates that instead of covering their losing short positions, managers opted to sell their winning or neutral long holdings.

Shorts Drive Underperformance

Global fundamental long/short funds registered a loss of 1.3% in the week ending Thursday, underperforming the MSCI World index's 0.8% decline, Goldman Sachs reported. The firm noted that the short side of these portfolios was the primary driver of the underperformance.

Systematic funds experienced a similar 1.3% drop, also fueled by losses on short positions. For the month of October, fundamental long/short funds are now down 3.7%, deepening from a 2.5% loss reported as of Oct. 19. This has trimmed their year-to-date gains to 8.9%.

De-Risking Hits One-Year Low

In response to the mounting losses, hedge funds engaged in net selling of global equities for the third consecutive week. The de-risking was heavily skewed towards reducing bullish bets, with long sales outpacing short covering by a ratio of 3.4 to 1.

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This activity pushed net leverage in fundamental long/short portfolios down to 47%, its lowest level in a year. While net exposure fell, gross leverage saw a slight increase. Regionally, Europe was a rare area of net buying, though this was primarily driven by short covering rather than the initiation of new long positions.

Market Implications and Squeeze Risk

The persistence of concentrated short positions has created losses for funds even in the absence of a significant market rebound. Analysts at Goldman Sachs noted that this positioning creates a potential vulnerability for hedge funds.

With portfolios holding their smallest long positions in a year, a sudden market rally could trigger a short squeeze, where managers are forced to buy back shares to close their losing short bets, potentially amplifying an upward move in the market.