Hedgies Fade The Rally As 'Flows' Dominate Positioning

Tyler Durden's picture

Only 17% of credit managers (real or leveraged) expect notable widening in spreads (a rise in risk) by year-end, according to Citigroup's most recent client survey. This increasingly extreme bullish sentiment seems dominated by the trend of inflows into real-money accounts (which have chased high-beta, high-yield, and peripheral exposure) whereas hedge funds have used this most recent rally to reduce exposure to the peripheral, notably limited their HY exposure, increased their leveraged loan (secured credit) positioning, and increased core exposure. There remains an over-arching belief that the trend in flows will continue and that these flows will dominate market movements - however, the divergence between European bank and high-yield credit exposures (real-money getting longer, leveraged money reducing/getting short) is as dramatic as it as ever been. The last time we saw such a bull/bear divergence between real- and leveraged-money was at the bottom in Q1 2009 (but that time real-money was short and hedgies were adding longs - and were right!)

 

The divergence between real-money (flows) and leveraged-money (trades) in high-yield is dramatic - hedge funds have not been this 'neutral' since before the crash in '09 and so divergent...

 

Guessing flow-expectations - trend is your friend - seems like a recipe for disaster (though a profitable disaster for months) as every seasoned credit manager knows, the downside from losers far outweighs the upside from winners (especially in high-yield currently with convexity and call constraints). The question is - if we see any risk pullback on disappointment from Draghi/Bernanke, marginal liquidity will evaporate very quickly and it seems hedgies are positioning for this (and shifting up the capital structure into secured positions).

 

Via Citi:

Above all, though, it just feels to us as though markets have got ahead of themselves. Spreads remain close to their tights. YTD total returns are the second best on record, second only to 2009. Although one investor told us that “being bearish about September is so consensus”, we doubt that many are positioned that way. The strength of the Italian auction, the way sectoral and peripheral positions have crept longer in our survey, and the correlations between market moves and central bank liquidity all suggest otherwise. Given the number of holes here, and not just in Jackson, the market still feels quite likely to stumble further.

Flows...

Real-money (left) vs hedge-funds (right) have seen very dramatically different positioning this month. So much for the 'money on the sidelines' myth...

 

One thing they do agree on - secured credit is a play: Leveraged Loan exposure rose on both sides...

 

But Only 17% expect spreads to widen more than the cost of carry into year-end - an extremely bullish positioning, no matter how much you hear about consensus concern for September...

 

Real and leveraged money remains short Peripheral and long Core - but as is clear from the charts below, real money has reduced its short periphery exposure and reduced its long core position.

 

Charts: Citi