Hedge Funds Are Not Buying Into This Bull Market: Should You?

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 |  Includes: DIA, GLD, QQQ, SPY, TLT
by: Damir Tokic

There is one fact about the current bull stock market (NYSEARCA:SPY) (NYSEARCA:DIA) (NASDAQ:QQQ) that everybody seems to ignore: hedge funds have been significantly underperforming the S&P500 benchmark.

The S&P 500 is up around 15% YTD, while the BarclayHedge Fund Index is up only 4.7% YTD (see figure 1). A more detailed analysis of the BarclayHedge Fund Index performance based on the sub indices shows that even the equity long-bias index is up only 7.4% YTD - underperforming the S&P benchmark.

Figure 1. BarclayHedge Hedge Fund performance YTD

YTD through
April

BarclayHedge Fund Index

4.72%

SUB INDICES

Convertible Arbitrage Index

3.76%

Distressed Securities Index

6.56%

Emerging Markets Index

3.27%

Equity Long Bias Index

7.42%

Equity Long/Short Index

4.71%

Equity Market Neutral Index

2.02%

Equity Short Bias Index

-12.49%

European Equities Index

3.24%

Event Driven Index

3.68%

Fixed Income Arbitrage Index

3.62%

Fund of Funds Index

4.38%

Global Macro Index

5.38%

Healthcare & Biotechnology Index

8.06%

Merger Arbitrage Index

1.10%

Multi Strategy Index

3.09%

Technology Index

-0.16%

Click to enlarge

One of the key characteristics of the stock market YTD is that the chart has been almost perfect for the trend followers - the market has been steadily going up without a serious correction. Thus, one would expect that the systematic trend-followers would at least match the benchmark S&P 500 performance.

However, the BarclayHedge CTA index (commodity trading advisors practicing mostly systematic trend following strategies) shows that the CTA subset of hedge funds is up only 1.9% YTD. More specifically, the Systematic Trader Index is up only 2.2% YTD (see Figure 2). In support, the IASG CTA Index is up 2.45% YTD, while the IASG Trend Following Index is up 4.83% YTD (see Figure 3).

Figure 2. BarclayHedge CTA performance YTD

YTD
through April

Barclay CTA Index

1.97%

SUB INDICES

Agricultural Traders Index

0.17%

Currency Traders Index

1.16%

Discretionary Traders Index

0.20%

Diversified Traders Index

2.09%

Fin./Met. Traders Index

1.72%

Systematic Traders Index

2.27%

Click to enlarge

Figure 3. IASG CTA performance YTD

Trend Following Strategy Index

4.83

Stock Index Trader Index

3.28

Diversified Trader Index

3.45

Systematic Trader Index

3.29

IASG CTA Index

2.45

Agricultural Trader Index

-1.28

Discretionary Trader Index

0.17

Option Strategy Index

-0.24

Click to enlarge

Implications for investors

Clearly, hedge funds and CTAs are not fully participating in the current bull market - they are significantly underperforming the S&P benchmark. Thus, it could be reasonably argued that the fundamentally oriented funds (discretionary and global macro) are not believers in the economic recovery. Further, even the technically oriented trend-followers are not believers in the current charts.

So who has been buying the current market? There were earlier reports that retail investors in January plowed a record $30 billion into stocks and exchange traded stock funds, which is the fastest inflow since 2000. Also, there was a report recently that central banks have been buying equities in record amounts. Based on these inflows, one can reasonably argue that stocks are possibly artificially pushed higher by central banks, and supported by retail positive feedback investors (buying in response to rising prices). A market like this can go much higher, but the risk of an eventual crash once the reality sets in outweighs the rewards.

Thus, we recommend that investors should be diversified in risk-on assets with negative correlations to equities, such as gold (NYSEARCA:GLD) and treasury bonds (NYSEARCA:TLT). Specifically, we recommend that all investors have a portion of their portfolios allocated to gold. Now it's an opportunity to add more to gold allocation given the recent correction in the price of gold. Further, we recommend that investors should also have a portion of their portfolios allocated to Treasury Bonds, or Treasury Bonds ETF, such as (TLT), despite the record low yields. The Japanese example shows that government bond yields can reach near 0% and remain at those levels for an extended period of time.

In summary, it appears that professional investors/traders have been skeptical of the current stock market rally, given their relative underperformance to the benchmark S&P 500. Investors should acknowledge that hedge funds are not buying into this rally, and thus, remain diversified with increased allocations to assets with negative correlations to equities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am a CTA.