Hedge Funds Shift to Stocks, Just in Time for Pullback

Outside the New York Stock Exchange on Wall Street. 
Adam Jeffery | CNBC
Outside the New York Stock Exchange on Wall Street. 

Hedge fund investors have begun to like stocks again—just in time for what appears to be a rough summer ahead for the equity markets.

Reversing a trend that began in March 2010, hedge funds in May saw inflows to equity-based products and outflows from fixed income.

The move replicates investor behavior in mutual funds, which have seen powerful streams of cash moving to stocks and away from bonds, to the extent that fixed income is poised to have one of its worst months ever.

In the meantime, the S&P 500 stock market index has fallen 2.7 percent in June.

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Fund flows tell a story of a market unsure of what to make of the road ahead, as rising yields dim the allure of bonds and the threat of a liquidity withdrawal from the Federal Reserve makes stocks a tough bet as well.

"Using classic fundamental analysis has been difficult in the markets that are heavily influenced by nonfundamental factors," said Peter Laurelli, vice president and head of industry research at eVestment. "We have large central banks with their monetary policies influencing global equity markets."

According to the latest data from eVestment, equity strategies saw just under $4 billion in flows for the month, while fixed income strategies lost about $90 million.

Pure bond funds still hold more assets than equity—$874 billion to $826 billion—in the $2.7 trillion industry, but that gap could start closing if the trends hold.

(Read More: Why Bullish BofA Thinks Market Gains Might Be Over)

Investors worry that if the Fed starts easing up on its liquidity program in which it pumps $85 billion a month into the purchases of Treasurys and mortgage-backed securities, that will send yields higher and push down bond prices.

Remarks Wednesday from Fed Chairman Ben Bernanke scared markets into thinking that the pullback on quantitative easing measures would come sooner rather than later, sparking a selloff that spanned all asset classes.

An equally troubling narrative for hedge funds, though, may be investor disinterest.

In a year when 68 percent of active managers are missing their benchmarks, flows into hedge funds have hit their lowest year-to-date pace since at least 2004.

(Read More: Active Managers Take a Beating, Thanks to Apple)

At the same time, the mostly passively managed exchange-traded fund universe has swelled to $1.43 trillion, an increase of 5.7 percent in 2013, according to XTF.

"Seeing the money on the institutional side go to the passive exposure, that might be the thing that makes me think this is a longer-term shift," Laurelli said. "Seeing it one month doesn't give me ultimate faith from an actively managed standpoint that the interest is fully there."

On the hedge fund side, fixed income strategies have done better over the past few years, justifying the exposure to credit.

However, Laurelli said investors seem intent on pulling money, particularly in the fund of funds space.

—By CNBC's Jeff Cox. Follow him @JeffCoxCNBCcom on Twitter.