Hedge Funds Suffered Worst Short-Squeeze Since 2009 In Q4 Amid “Trump Rally”

So the thing about “hedge” funds is that generally speaking, they’re supposed to provide a hedge.

That is, you don’t really want to be paying exorbitant fees to coke-sniffing, Hamptons-dwelling, Maserati-driving, “rockstar” managers if they can’t provide better risk-adjusted returns than the market.

Well, we all know that in the post-crisis, central bank-driven environment where the Draghi/Yellen/Kuroda tide has lifted all boats, outperforming benchmarks is a lost cause. And that’s put a whole helluva lot of pressure on the “2 and 20” crowd. Throw in some heckling from Warren Buffett and you’ve got a market that isn’t very forgiving when it comes to hedgies trying to “explain” why “2 and 20” is a better option than “10 basis points” in terms of how much you want to pay to get in on the action.

Late last month we noted that when it comes to risk-adjusted returns, there may be a light at the end of the tunnel for hedge funds. Recall this from BofAML:

Hedge Fund strategies are supposed to deliver better risk adjusted returns. At least that’s the the initial promise of being “hedged”, i.e. to navigate downside risks.

After several challenging years following the financial crisis, the risk-adjusted performance of hedge funds, measured by sharpe ratio, is improving. As of the end of February 2017, hedge fund delivered sharpe ratio of 3.8 over the trailing 12 months, compared to 1.3 by the S&P 500. Distress Credit, Convertible Arbitrage and Event Driven lead.

More importantly, hedge fund also delivered better sharpe ratio of 0.84 over the trailing 3 years, compared to 0.66 by the S&P 500. Merger Arbitrage and Equity Market Neutral lead over the three year time horizon. Meanwhile, hedge funds still trail the S&P 500 on annualized geometric average returns.

HedgeFundsSharpe

So that’s all fine and good, but as we noted four days ago, “it’s probably too late” in terms of anyone caring.

In a note out Wednesday, the very same BofAML takes a look back at Q4 vis-à-vis hedge funds and as it turns out (note: this isn’t surprising) they were positioned pretty much like everyone else. That is, long Trump trades (e.g. banks) and optimistic (relatively) on equities as an asset class (i.e. the least short equity ETFs on record). Another amusing finding: hedge funds were caught off guard by the Trump rally, resulting in the most short-covering since the end of 2009.

Via BofAML

HF ownership of bank stocks at record high. In aggregate, hedge funds net owned $33bn worth of bank stocks at the start of 2017, or a record high (Chart 1). Banks stocks account for 5.1% of the aggregated HF portfolio, also a record high. Meanwhile, HF net short 2.4% of KBE and 12.9% of KRE, suggesting that they are using those ETFs as hedge vehicles. On the long side, HF owns 2.2% of the outstanding shares of KBE and 11.6% of KRE.

Hedge1

HF least net short ETF since 2012; record long positions. Hedge funds increased their ETF long notionals by $7.4bn to a record high of $45.1bn (from Q2 2011), while decreasing their ETF short notionals to the lowest since Q2 2013. Hedge fund net short notional in ETFs fell to the lowest since 2012, driven by equity class which saw the least HF short in record. HFs net bought SPY, XLF and QQQ the most during Q4, by $8.2bn, $1.6bn and $1.3bn. Meanwhile, they net sold AGG, XLU and EMB the most and by $0.8bn, $0.5bn and $0.4bn respectively.

Hedge2

Shorts squeezed by “Trump Rally” in Q4 2016. Based on the quarterly 13F filings and estimated short positions of the equity holdings of 958 funds, we estimate that hedge funds short-covered the most stocks during Q4 2016 since the end of 2009. Net exposure rose to one year high in both dollar notional and as a percentage of AUM. Gross exposure fell from 175% to 170% QoQ- the lowest since Q2 2013. Cash holdings declined to 3.7% from 4.0%, below the five-year average of 4.0%.

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One thought on “Hedge Funds Suffered Worst Short-Squeeze Since 2009 In Q4 Amid “Trump Rally”

  1. Pingback: One Strategist Compared Hedge Funds to Passive Index Funds: “The Results Were Breathtaking” – Biiwii.com

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