March 10, 2025 - There has never been so much brinkmanship from a U.S. administration in modern times. The first month of executive orders has produced a cyclone of speculation and a great deal of action and reaction. The U.S. recently enacted tariffs on Canada, Mexico, and China. Within one day, the first two were paused.

Such moves have injected a great deal of volatility into markets. Conflicting business policies continue to add to the uncertainty and volatility. How can hedge fund managers hold to a medium-to-long-term strategy in a world where so much is uncertain? In this article, we look at how fund managers have been preparing and will continue to respond by lowering their beta exposure.

The Current State of Hedge Fund Activity

Hedge funds began the year divesting from equities. This culminated in a selloff the Friday before the new tariffs where hedge funds “sold nine of 11 sectors in the S&P,” reported Bloomberg. The most-sold groups included:

• Consumer discretionary
• Industrials
• Financials
• Energy
• Communication services
• Information technology

Meanwhile, retail investors bet the opposite. As fund managers sold stocks, retail investors poured $2.1 billion into equities. The market dropped upon news of the tariffs, though less than expected. Futures fell — the Nasdaq composite, 2.35%, and the S&P, 1.7%. It is clear everyone is reading the room differently and holds a wide variety of views on the long-term health of the U.S. economy.

On the one hand, JP Morgan Chase announced that it expected tariffs to lower U.S. growth by 0.5-1% and raise inflation by that same amount. On the other, a February 3rd Gallup poll found consumers buoyant. Sixty-one percent expect stocks to rise in value, the most since Gallup began including that question in 2001.

Yet, is it worth asking how useful projections, even when given sweeping tariffs, can be paused the next day? What is the long-term effect of those partnerships?

Reuters asked fund managers why they were not more aggressive in the administration's first few weeks. Several said they were hesitant to “get sucked in”, which appears to be trumping the fear of missing out. Many are hedging and investing in bonds and treasuries.

"Either inflation comes down and you get hit on margins, or it doesn't, and the Fed hits you because it doesn't cut (rates)," said Matt Smith, investment director at Ruffer LLP. "We are at our lowest equity weight."

Hedge Funds Have Been Readying for This Market

Hedge funds prepared for this presidency with their highest borrowing levels since 2010. They expect the dollar to continue to rise and protectionist policies to have some upsides for the U.S. economy. They also expect to benefit from the Trump administration’s promise to maintain lower taxes — notably, corporate taxes and the capital gains tax, via extension of the expiring 2017 Tax Cuts and Jobs Act (TCJA) – though the administration’s proposal on taxing of carried interest is not a favorable one for fund managers.

Hedge funds are adjusting their strategies in four ways:

• Reducing their beta exposure
• Managers want less exposure to technology stocks
• Managers want less exposure to emerging markets
• Managers are bullish on alternative investments

Reducing Their Beta Exposure

As they say, predictions are difficult, especially about the future. Right now, it feels even more fraught. As tariffs and the president’s 60+ executive orders (and counting) show, we can likely expect many quick policy decisions and reversals without warning.

In response, Reuters reports that hedge fund managers are reducing the portion of their portfolio dedicated to beta investments to between 15-5%, down from an average of 20%.

Managers Want Less Exposure to Technology Stocks

Tariffs aside, stock market routs like the one that followed news of China’s AI DeepSeek have managers on edge. As DeepSeek panic spread, the chipmaker Nvidia shed $600 billion in market cap. Since the industry has shifted to AI models, fortunes seem to rise and fall faster.

Managers Want Less Exposure to Emerging Markets

The administration’s protectionist policies seem certain to favor the dollar at the expense of our trading partners. They also favor reshoring operations. This makes it difficult to gauge the long-term value of foreign investments, even if they may be more attractive.

Managers Are Bullish on Alternative Investments

Fifty-six percent of hedge funds now have multiple managers and more capacity to shift into alternative investment strategies. For example, real estate and healthcare – from our conversations, hedge fund managers feel all the protectionist policies and declining trade make real estate and healthcare better investments.

Consider the Implications of New Investment Strategies

As hedge funds shift their investing strategies, there may be a learning curve for firms entering new territory. Managers newly entering commercial real estate will find that the standard capital stack has changed over the past few years, and mezzanine debt is preferred over equity. There also may be new tax consequences to consider. For example, municipal bonds are taxed federally unless they are tax-free, in which case they are probably still subject to state and local taxation. Citrin Cooperman’s Hedge Fund Professionals are here to support you each step of the way.

If you would like to discuss your allocation strategy and the accounting and tax implications of those holdings, please contact your Citrin Cooperman representative.