Hedge funds have only three weeks left to spend all their cash

Up in December, down in January?
Up in December, down in January?
Image: Reuters/Ralph Orlowsk
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It’s crunch time for hedge fund managers. Bank of America Merrill Lynch (BofAML) research says that hedge funds are “geared up for year-end rally”—with exposure at the stock market at record highs and cash balances at multi-year lows. They only have until the end of the year to maximize their performance—because that’s when their bonuses are calculated.

There are two dynamics at play: returns and optics. Investors generally expect the stock-market rally to keep going up through the end of the year. And so they want to own as much as they can to capture the most returns. Which, in turn, increases the likelihood of the market going up… the logic just circles up and up as the pursuit of returns begets returns.

And no one wants to miss out on the last gasp of the bull market. Jesse Felder, Publisher of The Felder Report and a former co-founder and head trader of a multi-billion-dollar hedge fund, tells Quartz, “There’s certainly a very strong ‘fear of missing out’ driving portfolio managers’ decision making right now.” At the same time, investors are maximizing their exposure so that their year-end portfolio shows as many of the best performing stocks of the year as possible.

Fund managers report positions as of the end of the year. No one wants to show too much cash in their fund given how good the performance has been this year.

What stocks are hedge funds investing in?

According to BofAML’s analysis of third-quarter filings, hedge funds’ biggest bets are in information technology, consumer discretionary, and health-care stocks. Tech stands out as the biggest bet, accounting for more than a quarter of all holdings, including the most popular individual holdings: Facebook, Alphabet, Amazon, and Microsoft.

Big tech stocks have been big performers this year and it seems that a lot of hedge funds think they will continue to be big performers through the end of the year. Silicon Valley isn’t universally loved though. While hedge funds’ biggest positive bet is on Facebook, their biggest negative bet is against Tesla.

History says the hedge funds will need to sell some of their positions very soon, though. Over the past five years, an average of 3.2% of capital has flowed out of hedge funds each year in January. Given that hedge funds only had 3.4% of cash on hand at the end of September, it’s possible that this rush for performance turns around quickly. That could pose a risk for big tech stocks since other institutional investors have been reducing tech stock ownership recently, leaving few buyers if hedge funds decide the big tech stock ride is over for now.

It might be time to take some of those big tech profits and cash out—before the hedge funds do.