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Equity hedge funds flee Covid-sensitive stocks amid fears of new surge

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Long/short equity-focused hedge funds are offloading or short-selling stocks that are most exposed to tighter Covid-19 restrictions, against a backdrop of surging coronavirus infections in Europe and heightening concerns surrounding the new Omicron variant.

With Covid-19 cases rising across Europe – and Germany, Denmark and Austria recently reintroducing tighter restrictions – equities-focused managers in the US and Europe have cut both their net and gross exposures in recent weeks, now converging near their long-term lows, Lyxor Asset Management observed in its latest Cross Asset Research commentary. 

Stock markets fell sharply towards the end of last week following the emergence of the potentially more serious Omicron strain – considered a variant of concern by the World Health Organisation – which has resulted in fresh travel restrictions and renewed restrictions in several countries.

In recent weeks, as Covid-19 infections have spread in Europe, investors have headed for value stocks, fleeing allocations in consumer discretionary names. Home-staying related companies have outperformed more sensitive sectors, such as entertainment and consumer services, as cyclical stocks weakened and flows moved towards defensive names, Lyxor noted. 

“In the US, managers are favouring energy, materials and industrial sectors, and are starting to buy tech on dips,” said Senior Strategist, Jean-Baptiste Berthon, and Bernadette Busquere Arnal, EU head of hedge fund research, in the note. “In Europe, managers are favoring industrial and financials, and are cutting their core-EMU stocks, which increases allocation to extra euro-area stocks.”

Lyxor added that long/short hedge funds are now locking in profits on stocks with high operational leverage, which benefited from pent-up demand but now face moderating top-line growth, and are moving into less-crowded names.

“Implicitly, these moves suggest that managers are starting to factor in greater risk due to Covid restrictions, though they do not seem to expect broad lockdowns. They anticipate that consumers would bear the brunt of the impact, while the manufacturing and economic activity would not be seriously jeopardised. 

“The announcement of new restrictions in Europe hit European managers’ alpha more than in the US,” the note added.

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