Hedge funds fleeing positions intensified towards the end of last week and may continue to dent European hedge fund managers' returns, a JPMorgan (JPM.N) note to clients seen by Reuters on Tuesday showed.
Hedge funds unwound positions in single stocks on Friday at the largest amount in over two years, with some activity comparable to March 2020, when portfolio managers cut market exposure during the pandemic.
European shares fell on Tuesday after Monday's sharp sell-off on U.S. growth concerns, and concerns about whether Germany's fiscal reforms might fail or be watered down.
When equities are sold in large sizes this can push down stock prices and impact market values. When funds large and small crowd into the same positions, larger funds selling stocks in bulk can trigger other smaller funds to exit their positions to mitigate their losses, as well.
"Smaller hedge fund managers face a precarious situation when large U.S. multi-strategy funds deleverage," said Bruno Schneller, managing director at Erlen Capital Management.
Smaller managers often have less money to trade with and rely on more concentrated positions to generate returns. When bigger funds sell stocks in bulk, the ability to buy and sell quickly can dry up, especially for less liquid stocks, said Schneller.
"Smaller managers are like dinghies in the wake of a supertanker—when the big funds shift course, the turbulence can capsize them. Their limited resources and flexibility make them particularly vulnerable to these cascading effects," said Schneller.
Stock pickers and multi-strategy hedge funds trading different asset classes have been forced to let go of positions, said the JPMorgan note.
European hedge fund managers with short positions against companies were also hurt by bigger funds buying back their short positions, the note added.
Hedge funds also take short bets, wagering that asset prices will fall. But when they need to ditch these positions, they buy back the stock, which if buying is big enough, can elevate stock prices.
The risk that too many people were crowded in certain trading positions had not completely eased, said the JPMorgan note.
Stock pickers that JPMorgan tracks finished February roughly down 2.5% and were so far, 1.6% down for 2025. Multistrategy funds tracked by the bank were down on average 1.7% for February and 1.6% for 2025 so far.
European markets are fragmented post-Brexit, with thinner trading volumes and less active participation from long-term investors, he added.
"A deleveraging shock could ripple across borders, hitting smaller exchanges harder and potentially sparking a feedback loop of forced selling. Banks, already cautious amid monetary tightening, might pull back further, exacerbating the strain," said Schneller.
