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Bailey McCann, Opalesque New York: Hedge funds have reversed a nine month trend, increasing leverage 5.4% year-on-year (YOY) according to new research from Bank of America Merrill Lynch Global Research. According to Mary Ann Bartels, lead hedge fund analyst at BofAML, leverage is up $286.6bn in August, after nine consecutive months of negative YOY growth since last November. The moves are a potential signal that investors expect equity markets will continue to trend to the upside in the near term.

Despite positive investor sentiments, report data shows that Q4 is likely to show overall underperformance from hedge funds despite a strong third quarter. "Since 1995, hedge funds outperformed the S&P 500 index by an average of 207bps in 3Q, and underperformed by 312bps in 4Q," Bartels writes. Historical data trends show that hedge funds tend to outperform in down markets and underperform when markets start to go up. The only time hedge funds were prepared for a year-end rally was the year 2000, when they posted strong numbers even as markets went higher.

The global diversified hedge fund index was up approximately 1.91% in 3Q’12 and up 3.31% year to date, still underperforming the S&P 500. In terms of individual strategies, Convertible Arbitrage was the best performer YTD and up 5.82%; Market Neutral performed the worst and was down 5.46%. Market Neutral and Equity Long/Short have both increased their market exposures to 1% net short and 19% net long respectively. Mac......................

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