'Did they know about the US airstrike on Iran in advance...Surprise in hedge fund investment details' [Global Money X-File]

Leverage at highest in 5 years

Last week, global hedge fund leverage reached its highest level in the past five years. According to analysis of their investment patterns, some believe they anticipated the US airstrike on Iran.

On the 24th, according to Reuters, hedge fund leverage reached a five-year high last week (June 16–20), as tallied by Goldman Sachs. Hedge fund position data from Goldman Sachs’ prime brokerage division regularly compiles long (buy) and short (sell) positions and leverage levels of major global hedge funds.

This data uses brokers that trade through Goldman Sachs. Because it is based on many hedge fund transaction details, it is a representative indicator of capital flows in the global hedge fund industry. Goldman Sachs is one of the world’s largest prime brokers, handling transactions for many large hedge funds.

However, this data aggregates only the positions of funds trading with Goldman Sachs, and thus does not represent the entire industry. Still, given that large funds with significant market influence spread their trades across multiple brokers, the Goldman Sachs data is considered a useful indicator that reveals the representative investment trends of hedge funds.

According to Goldman Sachs data, total hedge fund leverage in the third week of this month reached 294%, a sharp increase from 271.8% at the beginning of the year. This can be interpreted as an indicator of confidence in the market outlook. Hedge funds typically increase leverage when they are highly confident in their market outlooks. A high leverage ratio can accordingly amplify profits and losses from market changes.

Specifically, hedge funds strategically adjusted their positions by sector and region. For North American stocks, they maintained a net long (bullish) position. In contrast, they increased short (bearish) positions in European and Asian stocks, resulting in a net short there.

In other words, they became more positive on the US and allocated more to that market, while more funds bet on declines in Europe and Asia. Hedge funds remained 'modestly long' on North American equities, while European and Asian equities switched to 'net short' as short positions increased.

This regional difference reflects hedge funds’ macro views and risk perceptions. The net long on US equities reflects the belief that "the US market will remain relatively robust or defensive." The net short on Europe and Asia reflects the view of "downside risks" in those markets.

By sector, there was a clear increase in long positions in the financials and energy sectors. This reflects expectations for improved profitability in banks and insurance companies. In energy, more hedge funds bet on the rise in international oil prices, switching to net long. Conversely, movements in other sectors like consumer and technology stocks were less pronounced.

What is notable is the timing of the global hedge funds’ leverage expansion. On the eve of the US attack on Iran, hedge funds had already taken such positions. On the 13th, Israel bombed Iranian nuclear facilities, escalating Middle East tensions to the extreme. On the 21st, the US directly conducted further airstrikes on Iranian nuclear sites.

Changes in hedge fund positions (increased leverage, more financials bought, more European/Asian shorts, more energy stocks bought) precisely captured the effect of the US airstrike on Iran. The international oil price rose by more than 10%, boosting energy stocks. Over the same period, the European index (STOXX 600) and Asian index (MSCI AC Asia) fell by about 1–1.5%. Meanwhile, the US index (S&P 500) slipped just 0.2%, remaining roughly flat.

Hedge funds increasing their exposure to financials is thought to be due to the interest rate environment and monetary policy outlook. Recently, the US Federal Reserve Board (FRB) kept its policy rate steady at the June FOMC meeting, signaling a continuation of higher rates for now. A prolonged high interest rate environment can lead to improved interest income for financial institutions such as banks. Insurance companies invest premiums received from clients in bonds and other assets, generating management income. Higher interest rates boost investment returns, thus benefiting from the high rate environment.

The bearishness on European and Asian markets by hedge funds is seen as linked to instability in the Middle East. The airstrikes on Iranian nuclear facilities heightened risks to the global oil and energy supply chain, especially for Europe and Asia, which are particularly vulnerable here. A surge in oil prices can put inflationary pressure and economic slowdown pressure simultaneously on countries highly dependent on energy.

China reportedly relies on the Middle East for over 30% of its oil imports. In Europe, since the Russia-Ukraine war, reliance on Middle Eastern oil and LNG has grown, making these economies more vulnerable to energy price shocks. By contrast, the US, after the shale revolution, has a high degree of energy self-sufficiency and is less affected by oil shocks from the Middle East.

There is also analysis that hedge funds were engaging more in risk management or probability bets, rather than exactly predicting the US attack on Iran. The expectation that the US might intervene was already dominant in the market. Sometimes, hedge fund behavior looks prescient only in hindsight. If the US had not attacked Iran, their positioning could have been explained by Fed policy or other economic indicators.

Gwyn Roberts, head of research at PivotalPath, a hedge fund research firm, recently argued, "Trend-following funds have failed to latch onto any clear trend, being shaken by rapid market moves. Meanwhile, macro hedge funds have actually leveraged volatility, delivering standout performance this year."

Written by Kim Juwan, kjwan@hankyung.com