Hedge funds are increasing bearish bets against the value of equities as the stock market rout deepened this week.

Initially caught off guard by the volatility of markets in August, hedge fund investors had sought to reduce risk and hedge existing positions in the early weeks of the month.

But they are now increasing short positions as concerns mount over the strength of global economic recovery.

According to the Data Explorers Long Short Ratio for US equities, investors have increased their short positions from May, when the relative amount of shorting was at its lowest level since 2005.

The ratio now stands at 11.71, meaning that investor long positions outnumber the shorts by almost 12 times.

The lower the number, the greater the amount of short selling, in effect. The ratio has fallen as investors have increased short positions from the high seen on May 12 when it reached a six-year peak at 13.19

The move came as investors around the world have shied away from risk and piled into safe assets such as Treasuries, pushing yields on the benchmark 10-year US bond below 2 per cent for the first time in over 60 years.

Bond yields move in the opposite direction to prices.

The increase in shorting reflects increased hedging as much as it does a more bearish view on the economy.

Several hedge fund managers spoke of being whipsawed by market movements, putting short sales on one day only to see the market rally violently the next, leaving many to head for the sidelines or only trade in highly liquid securities.

Stephen King, founder and chief investment officer of C12 Capital Management, a hedge fund with $1bn under management, points to the jaggedness of recent moves in the S&P index, one of the most liquid markets in the world.

“It portrays a market where both hedge funds and dealers have de-risked as much as possible, with the end result that liquidity is really awful,” he said. “It is not representative of anything behaving well.”

He also cautioned that the volatility makes it very costly to hedge or to attempt to play the market moves.

“It’s very expensive to take the short-side view,” he said.

Many hedge funds have turned to exchange traded funds, which are liquid and relatively cheap to trade, as a means to hedge their existing exposure and express an bearish investment view.

“We’ve seen increased shorting of broad based exchange traded funds as an overlay to long positions”, said Philip Vasan, head of Prime Services and Capital Services for Credit Suisse, “It grew over the summer, and ETF liquidity allowed a rapid reaction in August. In fact, US ETFs as a percentage of dollar trading volume jumped from 25 per cent through June to 40 per cent now”, he added.

In stocks, hedge funds had relatively low levels of leverage in place at the start of the month, according to the prime brokers responsible for lending to the funds.

“Leverage has stayed very low,” said one prime broker. “It fell as they sold into end of last year and never went back up.

“They missed that 1,255 to 1,355, 100-point rally [on the S&P 500], with a couple of fits and starts”, the prime broker added, describing hedge funds as being caught out by swings in the market.

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