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It's been a while since we last checked in on the latest hedge fund exposure levels so today we present Bank of America Merrill Lynch's Hedge Fund Monitor. To start the new year, they estimate that long/short equity hedge funds have further reduced exposure to now just 25% net long. Historically, average equity exposure has been 35-40% net long equities.

The last time we saw hedge funds reduce risk assets in late October, the market fell around 3.6% about a week later. Maybe it was a bit of luck with market timing, but it seems as though hedge funds in general have been ahead of the curve with their recent maneuvers.

After the market's furious rally over the past few months, it's clear that some managers think the equity market is overbought in the short-term and expect a pullback. However, many strategists like Jeff Saut believe dips should be bought.

Looking through current hedge fund trades across asset classes, there are a few notable plays that stick out. First, hedgies continue to hold crowded long positions in soybeans and corn. Crude oil and Copper are also crowded net long plays in the commodities spectrum. And turning to forex, we see that hedge funds have pressed their shorts against the euro. Last, in interest rate plays, managers hold a crowded net short in the 10-year notes.

Long/Short Equity

As mentioned above, the l/s equity strategy has seen a sizable reduction in net long exposure as funds lock-in gains. These hedge funds still favor large cap names (with a preference of growth over value).

Market Neutral

Interestingly enough, market neutral funds not have around 5% net short exposure. This comes after they spent the majority of 2010 with net positive market exposure. These funds have shifted from growth plays to value.

Embedded Below is Bank of America Merrill Lynch's Hedge Fund Monitor:

Hedge-Fund-Monitor-BofA - You can download a .pdf copy here.

So it seems that hedge funds continue to favor commodities here as inflationary plays. A month ago, we detailed that Dan Arbess' Xerion Fund preferred commodities. John Burbank's Passport Capital also favors hard assets.

It's clear hedge funds are protecting some of their gains from the equity rally as exposure has been reduced further. Hedgies reduced risk assets right before the last market decline, so we'll have to see if they've sent another warning sign with their latest reduced exposure.

Disclosure: None

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Source: Hedge Funds Reduce Equity Exposure to 25% Net Long