“Cause for concern”: Man Group sounds warning on risk appetite and positioning

Man Group has raised the alarm over elevated risk appetite and potentially hazardous market positioning following the recent seismic factor reversal, with some hedge fund strategies potentially gambling on “prior winners continuing to win”.

In a market commentary on Tuesday, the London-listed hedge fund giant pointed to a continued close correlation between hedge funds’ positions and momentum and value factors – a positioning that shows “little sign of shifting after the dramatic factor reversal two weeks ago.”

This positioning – coupled with gross and net exposures for equity long/short hedge funds now “comfortably” at five-year highs – suggests “funds remain fully committed to prior winners continuing to win, and markets continuing their march higher,” Ed Cole, managing director, equities at Man GLG, wrote in the company’s weekly ‘View From The Floor’ note.

A number of hedge fund strategy types were rocked by the recent sell-off in momentum stocks as investors piled into value companies, a rapid market rotation driven partly by the positive announcements regarding a Covid-19 vaccine breakthrough earlier in the month.

“Investor risk appetite, in combination with market positioning, are currently giving us some cause for concern regarding the direction of the market,” Cole observed.

The note suggested current risk appetite reflects “real levels of euphoria”, with risk appetite measurements against the MSCI Emerging Markets Index – “one of the riskier asset classes globally” – in the 98th percentile over a 25-year range. Most meaningful corrections have occurred against a backdrop of risk appetite above the 95th percentile.

“Historically, this data series has worked well as a buy signal, because panic typically reaches a synchronised crescendo. It works less precisely as a sell signal, because tops normally form quite slowly and over time,” the note explained.

“We’re unsure of the catalyst, but when conditions are ripe, the narrative for why a sell-off has occurred typically comes after the event.”