Managed futures funds can flip from being bullish to bearish in a flash. And that’s a lurking risk – a big one

Managed futures funds could fuel a big sell-off soon

A toxic mix of factors could trigger a self-sustaining downturn in already top-heavy markets.

Consider trade war machinations, a bull run in stocks that is long in the tooth, and the Fed’s uncertainty.

Add to this a group of hedge funds, known as managed futures funds, that have loaded to the gills with bullish bets on the market.

And these guys, $300 billion in size, are computer-driven.

Leverage at uncomfortable levels

Managed futures funds have their bullish positions funded through leverage. This leverage is now at levels observed when the markets peaked in January and September 2018, according to a note from Morgan Stanley.

These trend-following funds which extensively use automated trading can reverse their positions on the mere whiff of a change in trend caused by any macro event or risk.

Such an occurrence could “activate forced selling” from these funds, says Morgan Stanley.

Self-perpetuating downtrends

When such a macro event happens, investors would be aghast to see significant gap-down declines in stocks, “due to the average trend follower being extremely net long,” according to Robert Duggan, Partner at SkyBridge Capital.

Worse, the sell-offs could feed on themselves, exacerbating the downtrend.