Hedge fund styles and macroeconomic uncertainty

This paper examines the dynamic trading strategies implemented by hedge fund managers using
a Kalman filter of hedge fund betas across styles. We further investigate the risk drivers of
dynamic trades, examining which conditioning/macroeconomic variables strongly lead the time
variation in fund trades. We report the significance of macroeconomic factors such as interest
rates, dividend yield, GDP growth and US unemployment. We show that hedge fund managers
do control the intensity of their exposures according to economic uncertainty and that differences
between up- and down-market regimes can be observed. Commonly, Hedge funds tend to dislike
high-dividend paying stocks. Besides, all hedge fund styles are shown to display pro-cyclical exposures
towards directional equity factors as well as credit and liquidity risks. Small growth stocks,
however, are revealed to be crisis investments whose allocation increases with unemployment,
inflation or volatility. As volatility increases, the value of growth options embedded into growth
stocks indeed increases. Growth stocks are shown to hedge market reversals and volatility. The
outperformance of growth companies in recessions might also relate to their cost flexibility. Allocation
to small stocks embed strong micro risks and might also constitute a hedge in economic
slowdowns. This might explain why some funds with such a particular investment focus appear
to be countercyclical.