Risk appetite returns, but with seatbelts fastened

Global activity remained resilient in August, though regional divergences persisted. Eurozone sentiment, employment and investment improved despite energy pressures and weak household demand, supporting a cautious ECB stance. US growth and employment stayed firm, while inflation moderated gradually. China remained the main weak spot amid soft consumption, property weakness and limited credit demand, as well as an increasing reliance on exports.

Risk assets advanced on renewed AI and software enthusiasm. US equities performed strongly, led by Technology and Energy, while Europe was more subdued, with France underperforming. Materials outpaced defensive sectors. Asian markets strengthened, particularly Taiwan, Japan and Korea, while China and Hong Kong remained weak. Despite this positive backdrop, hedge funds turned more defensive, sharply reducing non-US equity exposure and unwinding positions in semiconductors, hardware and other AI-infrastructure assets.

Fixed income markets remained sensitive to policy and supply concerns. US long-end yields moved higher over the month despite Treasury liquidity-support buybacks, as investors continued to focus on large fiscal deficits, heavy sovereign and corporate issuance and a less predictable Fed communication framework. In credit, strong issuance, particularly financing linked to the AI investment cycle, contributed to some spread widening, although broader corporate balance sheets remained supportive.

The month therefore combined resilient growth and positive equity returns with a clear shift beneath the surface towards higher-quality, lower-beta exposures. Simultaneously, hedge funds reduced momentum and crowded AI exposures and increased select Financial, Energy, Healthcare and defensive positions, suggesting greater selectivity rather than an outright retreat from risk.

The HFRX Global Hedge Fund EUR Index was up 0.65% over the month.  

L/S Equity

Equity long/short funds generated positive absolute returns in August, but struggled to capture the equity rally: Morgan Stanley estimates that global L/S funds captured around 50% of world equities upside. Short books were the main drag, rising more than longs, with software particularly painful as heavily-shorted SaaS rebounded sharply. Funds continued to de-risk crowded AI infrastructure, semiconductor, hardware and memory exposures, while favouring hyperscalers, higher-quality Technology and select Financials, Energy and Healthcare. Non-US long selling was exceptionally strong, particularly in Europe and Asia. Going forward, lower crowding and greater dispersion should improve stock selection opportunities, although short squeezes remain a key risk.

Global Macro

Global macro was among August’s strongest hedge fund strategies, benefiting from pronounced moves across rates and commodities. Rising global bond yields (US , EUR, JPY) fuelled by stickier inflation, strength in oil and agricultural commodities and currency volatility provided directional opportunities. US and long-term yields remained under upward pressure from persistent fiscal deficits, heavy Treasury and corporate issuance and uncertainty around Fed communication, while Middle East tensions supported energy volatility. Monetary policy divergence, fiscal concerns and geopolitical uncertainty continue to be a favourable tailwind for Global Macro strategies, although with some reversal risk.

Quant Strategies

Quant and multi-manager strategies experienced another volatile but modestly positive month. Momentum and short interest were the largest detractors, while liquidity, analyst sentiment and short-term reversal contributed positively. Managers responded by reducing momentum exposure and the short interest factor, reflecting the sharp reversal in previously crowded trades. High cross-sectional dispersion remains supportive, but abrupt factor rotations argue for diversified signals and disciplined exposure management.

Fixed Income

Fixed income relative-value strategies produced modest positive returns despite a difficult directional bond market. Opportunities were created by higher Treasury volatility, curve repricing and unusually heavy IG corporate issuance. Hedge funds also remain important participants in Treasury basis trades, while the changing composition of Treasury ownership and persistent deficits are contributing to greater market sensitivity. Elevated rate and curve volatility should sustain relative value opportunities, although crowded basis positions, repo financing conditions and sudden liquidity dislocations remain important risks.

Event Driven

Event-driven strategies delivered modest gains, although results varied considerably by sub-strategy. Merger arbitrage was the stronger component, gaining 0.87% according to the HFRX ED Merger Arbitrage Index, whereas special situations were slightly negative as some catalyst-driven equities weakened. Event-driven leverage remained relatively elevated, but broadly within the range observed over recent years. The outlook is cautiously positive, particularly for special situations and balance sheet catalysts, while merger arbitrage remains dependent on regulatory clarity and financing conditions.

Credit Arbitrage

Credit arbitrage faced a mixed but increasingly opportunity-rich backdrop. Corporate balance sheets remained generally healthy, but heavy issuance, especially financing associated with AI investment, created greater security and issuer dispersion. Wider hyperscalers spreads were helping markets absorb the supply. Stabilised data-centre securitisations held up better than unsecured corporate debt. Rising Treasury yields and heavier issuance also increased relative value opportunities between cash bonds, CDS, curves and capital structures. Dispersion and supply should remain supportive for long/short credit and capital structure arbitrage, while tight aggregate spreads favour idiosyncratic rather than broad directional credit risk.