One can argue that few industries have “suffered” more under central planning than billionaire hedge fund managers. It is no secret to regular readers that over the past decade, hedge funds have not only underperformed the market, but had as a group failed to generate “alpha” since 2011.
As we have shown year after year, the centrally-planned “New Paranormal” has been a disaster for traditional alpha generation, since with all conventional, fundamental-analysis relationships flipped upside down thanks to central banks (which as BofA calculated earlier have purchased some $1.7 trillion in assets in 2017 alone, in addition to roughly $18 trillion since Lehman) the only way to generate outsized returns for one’s investors (and one’s offshore bank account) was to be massively levered beta, or merely wrong. Back in April, none other than Goldman confirmed as much when it found that QE “triggered the onset of active’s run of underperformance.”
That underperformance, however, came to an end in late 2016 and early 2017, as a result of two things: a huge clustering by the marquee investors in a small group of (mostly tech) stocks, a surge in gross leverage to record highs, boosting returns, and a collapse in short positions.
According to the latest Hedge Fund Tracker forecast released by Goldman overnight following the just concluded 13F season, the bank calculates looking at 803 hedge funds with $1.9 trillion in gross positions, that the average equity hedge fund has posted a 7% YTD return, “benefiting from large allocations to growth stocks and the Info Tech sector despite low volatility and dispersion.”
And yet, despite its “best” half-year performance in years, the average equity hedge fund not only can not outperform the S&P, but is lagging by nearly 50% as the chart below shows. Worse, all hedge funds have returned just 4% YTD, massively underperforming the average plain vanilla mutual fund, whose YTD 10% return crushes the so-called “smart money.” As for macro hedge funds with their -1% YTD return, well that’s why the entire industry is being redeemed into oblivion.
That said, after years of missing out on the S&P rally – carefully micromanaged by every single central bank in the world whose employees have become Chief Risk Officers for the world’s stock indices – hedge fund LPs will be delighted even with a modest underperformance to benchmarks. And for that they have to thank a small group of shares, also known as the Goldman Hedge Fund VIP basket:
Our Hedge Fund VIP list of the most popular long positions, which includes most of the “FANG” and “BAT” stocks, has outperformed the S&P 500 by 725 bp YTD (19% vs. 12%). With strong returns so far this year, elevated valuations and policy uncertainty have driven funds to trim net exposures even as short interest remains low.
As Goldman adds, after lagging in late 2015 and early 2016, the bank’s Hedge Fund VIP basket soared to close the performance gap with the broad market. The basket of most popular hedge fund long positions suffered its worst historical underperformance vs. the S&P 500 in late 2015 and 1H 2016 (-17% vs. -3%), following a series of spectacular pharma and healthcare blowups, first and foremost by Bill Ackman’s investment in Valeant, which single-handedly crushed the performance of ever Pershing Square idea dinner participant for years. Since the start of 2H 2016, however, the basket has rallied back to outperform the S&P 500 by 19 percentage points (+45% vs. +26%).
Meanwhile, there was an odd dispersion between hedge fund gross and net leverage, with the former surging to new all time highs, while the latter sliding back to average levels:
Funds trimmed net leverage entering 3Q, protecting 1H gains in the face of decelerating economic activity, elevated policy uncertainty, and record high equity prices. Our analysis of fund filings and short interest data suggest funds carried a net long exposure of 47%, close to the median level since 2005 and a modest decline from 1Q 2017. Similarly, the data calculated by our colleagues in Goldman Sachs Prime Services on exposures in their business show that net leverage has declined from cycle highs in the last few months, even while gross exposures continue to climb to record levels.
Also helping returns was the ongoing decline in short interest among “hedge” funds, who are increasingly called that only for the sake of tradition as most have learned that actively “hedging” the downside in a time of central planning, simply means getting steamrolled by a market which refuses to drop and by shorts which randomly squeeze out even the “strongest money.” As Goldman notes, “short interest as a percent of S&P 500 market cap sits just below 2.0%, close to the lowest levels in five years and roughly unchanged since January.“
Looking at clustering, in light of the rising importance of a handful of Hedge Fund VIP positions, it was to be expected that Hedge fund crowding in the most popular positions rose in 2Q 2017, and is now just shy of the extremes reached in 2016. The average hedge fund carries 68% of its long portfolio in its top 10 positions, just below the record “density” of 69% in 1H 2016. Similarly, our hedge fund crowding index signaled an increase during 2Q
Of course, concentration is a two-edged sword – as Bill Ackman so vividly recalls – and as the next two charts below show, much of the future performance of the hedge fund space is intimately linked with just 7 stocks: the FANGs and BATs, by far the most actively owned group of stocks by the HF community:
The increase in hedge fund portfolio density mirrors the rising share of S&P 500 market cap accounted for by the 10 largest index constituents… Among the top positions, ownership of “FANG” (FB, AMZN, NFLX, GOOGL) and other US growth tech stocks remained fairly constant. At the same time, while hedge funds increased ADR ownership of “BAT” (Baidu, Alibaba, Tencent), the favorite Chinese growth tech stocks, they remain less-owned relative to their US counterparts. While the lack of foreign equity disclosure in 13-F filings obscures some hedge fund investment in the Chinese firms, all of the “FANG” and “BAT” stocks are members of our Hedge Fund VIP basket except for Tencent, which lacks an exchange-traded sponsored ADR.
So putting it all together, here are the 50 positions which make up the latest GS VIP list, i.e., the 50 most popular hedge fund longs…
… and the list of 50 stocks representing the most important short positions.
Finally, here are the 20 stocks with the highest positive and negative changes in popularity.
As a reminder: traditionally, being long the most shorted hedge fund names and shorting the most favored ones has been a source of double digit alpha ever since 2011, and while this year that may have been different, for now, there is no reason to assume this normalcy will persist into the coming, volatile fall and winter period.