Hedge funds up bullish bets on stocks to record level

  • Hedge funds increased their net long exposure to stocks to $824 billion heading into the fourth quarter, a 3.8 percent quarterly rise and new record.
  • The bet paid off as the S&P 500 climbed 4.5 percent in the quarter, part of an 18.6 percent surge in 2017.
  • Hedge fund managers bought ETFs that focus on utilities and emerging markets and sold funds that track the S&P 500, Nasdaq and Japan.
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In another sign that stock fever is spreading through investors and possibly signaling that the bull market is in its late stages, hedge funds have increased their equity exposure to record levels.

The $3.2 trillion industry increased its exposure to the stock market on net to $824 billion heading into the fourth quarter, an increase of 3.8 percent, according to Bank of America Merrill Lynch. That came as positions focused on the market rose to $1.45 trillion, also a record.

The market is heading into the closing weeks of 2017 on a tear. The S&P 500 has surged 18.6 percent for the full year, including a 4.5 percent rise in the fourth quarter.

Hedge funds helped contribute this year to a big jump in flows to exchange-traded funds.

ETFs saw nearly $300 billion in new investor cash through November, a total greater than the entire industry combined has ever received in a calendar year, according to State Street.

For hedge funds, the strategy is sometimes different than retail investors. Managers can use ETFs to short or bet against, the market, and the industry's net short position expressed through ETFs increased slightly during the quarter to $53 billion, from $52 billion.

During the quarter, hedge fund managers scooped up shares of ETFs that focus on utilities and emerging markets and sold popular funds that track the S&P 500, Nasdaq and Japan.

As for overall positions, hedge funds increased exposure to cyclical sectors including tech, materials and health care and decreased positions in consumer staples and financials. Specifically, managers purchased $6.9 billion of biotech heading into the fourth quarter, for a total position of $43 billion, good for 5.2 percent of total portfolio allocation.

The biotech bet, however, has not paid off. The sector, as measured by the iShares Nasdaq Biotechnology ETF, has tumbled 7 percent in the fourth quarter.

Hedge funds headed into the year's close with a 26.1 percent allocation to technology, the highest in a year, while financials exposure fell to 12 percent, the lowest in 2017. Tech is up about 4.5 percent in the quarter and financials have gained more then 7.5 percent.

WATCH: Something else hedge funds are buying: bitcoin.