Hedge Funds Were Caught On The Wrong Side Of Two Big Trades Last Week

Stocks are rallying again on Tuesday, rebounding sharply after a couple of shaky weeks to start October.

And while the move in stock indexes grab the most headlines, most of the big action over the last few weeks has happened in the bond and currency markets.

And some of the biggest, or at least most active, players in these markets aren't Mom-and-Pop or institutional investors, but hedge funds.

In a new report, Societe Generale gives an update and an overview of how hedge funds were positioned during the recent volatility, and overall, they were a little caught out.

As SocGen simply puts it: "Hedge fund expectations of rising US bond yields, implemented through short Treasury positions and long dollar trades, left them maximum exposed in the correction last week."

Additionally, hedge funds were caught out on their bet that volatility would remain low, with SocGen writing: "In a low volatility environment, hedge funds typically make money on short equity volatility positions. However, the volatility spike last week left them running for cover."

This chart from SocGen shows that hedge funds were net sellers of 10-year US Treasury bonds, meaning they were betting that yields would rise, while yields have in fact fallen over the last month.

And this move culminated in the panic selling of 10-years that saw yields fall as low as 1.86% last Wednesday morning.

Hedge funds have also been selling volatility, or betting that the VIX and other volatility measures would remain low, through the fall.

Last week, the VIX spiked to its highest level since last 2012. Over just the last five trading days, however, the VIX is down more than 25%.

Overall, however, SocGen said that beyond short term volatility, it is too early to drastically reduce risk exposure: "As stops have been reached, hedge funds have had to unwind some of their trades, implying that their performance will not benefit when markets turn around. However, beyond short term volatility, we argue that it is still too early to drastically reduce risk exposure."

Here's an overview of where hedge funds stand across a variety of asset classes.