Hedge funds shift as yields rise, equities hold near records

Hedge funds are reducing long-duration government bond positions and increasing short-term hedges as US Treasury yields approach 5%, while equities have shown limited stress and the S&P 500 trades less than 3% below its Aug. 13 high.

The US 10-year Treasury yield has moved back toward 5%, a level that has in the past coincided with higher equity volatility. A prolonged rise above that threshold in 2007 preceded a roughly 5% drop in the S&P 500 over two months before larger losses followed. The yield last reached 5% in October 2023.

The recent rise in sovereign yields followed an inflation shock after the pandemic and a jump in oil prices linked to the Iran conflict. Those developments have increased expectations for tighter monetary policy and triggered bond sell-offs across major markets.

Alternative managers are cutting allocations to long-duration sovereign debt and using more short-dated hedges while reallocating some exposure into equities. HSBC strategists wrote: “The reduced diversification provided by sovereign bonds has contributed to declining bond allocations and greater use of short-term hedging strategies, while equity allocations have increased.”

Equities have been supported by strong corporate results and continued investment linked to artificial intelligence. Major technology firms including Apple and Microsoft remain close to record levels on expectations of sustained AI spending. Second-quarter S&P 500 earnings are estimated to have risen about 53% year-on-year, or roughly 49.5% excluding energy, and full-year 2026 earnings are forecast to grow about 35% after a projected 14% rise in 2025. Alphabet and Amazon reported robust cloud expansion, with combined adjusted earnings growth near 35% when excluding mark-to-market gains.

Some parts of the market have weakened as yields climbed. Certain semiconductor stocks and a range of Asian AI-linked equities pulled back after earlier gains. The Russell 2000 has outperformed the S&P 500 so far this year but has fallen more than 5% from its August peak; smaller companies are typically more sensitive to higher borrowing costs because they rely more on external financing.

Domestic economic data have supported risk assets. Employment growth accelerated in August, helped by a rebound in leisure and hospitality jobs. The Bureau of Economic Analysis raised its estimate of consumer spending growth in the first half of the year to 3.4% from an initial 3.2% reading. Analysts at Aberdeen noted: “Consumers, labour markets and corporate balance sheets had generally performed better than anticipated.”

Hedge funds are monitoring whether strong earnings and economic resilience will offset pressure from higher yields or whether sustained increases in borrowing costs will widen volatility. Current strategies emphasize shorter-duration hedges, selective equity exposure and close tracking of earnings and AI spending trends.