Recently, I wrote some stuff about hedge funds and mutual funds.
If that’s the kind of thing you’re into (or if you want to read about hookers, groupies, Xanax, cocaine, and Maseratis) you should check out these two posts:
- Hedge Funds Are Still Trailing The S&P And Cocaine Ain’t Gettin’ Any Cheaper
- 2/3 Of Growth And Value Funds Are Beating Their Benchmark. Guess Why…
The overall message you’ll get if you peruse those is that fund managers of all stripes are kinda throwing in the towel on trying to beat benchmarks.
Well, that’s not 100% accurate and indeed, some people would try to say it’s not accurate at all.
But what they (funds) are doing is simply levering up and overweighting the names and sectors that are driving benchmark returns and then calling that “alpha.” And it is alpha – sort of. But that’s some pretty dumb fucking alpha. (As you’ll read below, Goldman tries to spin this “strategy” as “alpha generation from bottom up stock picking.” I’m not convinced.)
“Hedge funds lifted leverage to post-crisis highs as their most popular long positions outperformed in a rising equity market,” Goldman wrote a couple of weeks ago, adding that “net exposure (73%) is now roughly in line with its cycle highs reached in 2013, while gross leverage (234%) has soared to new post-crisis highs.”
On the mutual fund side, growth and value funds are outperforming for one simple reason. “Information Technology has outperformed the S&P 500 by 11 percentage points YTD (17% vs. 7%), 8 percentage points higher than any other sector [and] Info Tech is the most overweight sector among large-cap growth funds (+422 bp),” Goldman explained in their latest mutual fund monitor, before going on to note that “Large-cap value funds are also overweight Info Tech by 277 bp vs. the Russell 1000 Value index.”
See? It’s so simple!
Well on Friday, after two straight weeks of providing no market color in their weekly US equities “kickstart” note, Goldman was apparently short on commentary again and so what they did was, they just kind of rewrote what they explained in the hedge fund and mutual fund monitor pieces cited in the two posts linked above.
Happily, this is one of those times where a concise recap of something that was written previously is actually helpful in terms of crystallizing things and so, we present excerpts below…
Both mutual fund and hedge fund returns in 2017 have benefited from high allocations to the Information Technology sector, which has surged by 21% YTD and contributed 46% of S&P 500’s YTD return. Our analysis of $1.9 trillion of long and short hedge fund positions revealed a 25% net exposure to the Tech sector. Our review of $1.3 trillion of large-cap mutual fund assets showed core funds had a 22% allocation to Tech (13 bp underweight vs. S&P 500), growth funds with a 37% Tech weight (422 bp overweight vs. Russell 1000 Growth index), and value funds with a 13% weight (277 bp overweight vs. Russell 1000 Value benchmark).
Looking forward, shifts in sector allocations during 1Q suggest different expectations for the Info Tech sector. Although they remain overweight, mutual funds faded the Tech rally. Managers reduced positioning in the sector to 133 bp overweight vs. their respective benchmarks. However, hedge funds have continued to buy the rally. Hedge fund managers increased net positioning in Info Tech by 82 bp, ending the quarter 352 bp overweight relative to the Russell 3000 (25% vs. 21%). We recognize hedge funds do not manage assets relative to an index, but interpreting sector tilts requires orientation to some benchmark.
While hedge funds and mutual funds agree on prospects for the Tech sector, they have clashing views when it comes to Financials. Financials is the most underweight sector among hedge funds relative to the Russell 3000 (-500 bp), but it is the second-most overweight sector in large-cap mutual fund portfolios (+198 bp). The 4 pp difference in Financials’ allocation between mutual funds (14%) and hedge funds’ net exposure (10%) is second only to Materials, where mutual funds allocate 3% of assets compared with hedge funds’ 7% net weighting. Allocation changes in 1Q suggest that managers have increasing conviction in their respective views. Large-cap mutual fund managers (core, growth, and value) boosted their Financials’ overweight by 66 bp vs. their respective benchmarks while hedge funds increased their underweight by 52 bp (relative to the Russell 3000).
High conviction in core positions is evident in funds’ portfolio density. The 10 largest positions account for 67% of hedge fund long equity assets, twice the 32% weight in large-cap mutual funds (Exhibit 2). Hedge fund concentration has receded slightly from its all-time high of 69% in 1Q 2016, but remains above average. Current mutual fund portfolio density is in line with the 10-year average of 32%. For context, the 10 largest S&P 500 constituents account for 19% of the index. It is “fake news” that we are in a narrow breadth market; the ratio is in line with its 10-year average.
Among hedge funds, the highest conviction stocks are increasingly FAANG: Facebook, Amazon, Apple, Netflix, and Alphabet (GOOGL) (Exhibit 3). All 5 FAANG stocks are constituents of our Hedge Fund VIP basket (ticker: GSTHHVIP). In contrast, while GOOGL, FB, and AMZN are constituents in our Mutual Fund Overweight basket (GSTHMFOW), AAPL and NFLX are in our Mutual Fund Underweight basket (GSTHMFUW). In fact, AAPL is the most underweight holding across large-cap mutual funds on average (-90 bp or 2.7% vs. a blended average benchmark weight of 3.6%).
Alpha generation from bottom-up stock picking is the story of 2017! Our baskets of popular hedge fund and mutual fund long positions have both outperformed YTD and during the last 12 months (Exhibit 4). Hedge fund popular long positions have outperformed a corresponding basket of hedge fund short positions by 702 bp YTD (13% vs 6%). Similarly, our mutual fund overweight basket has outperformed our mutual fund underweight basket by 558 bp during the same period (12% vs 7%).
Follow the proverbial “smart money.” The favorite stocks shared by both mutual fund and hedge funds have generated higher median YTD returns than the consensus most out-of-favor stocks (23% vs. 5%). Furthermore, stocks favored by both mutual funds and hedge funds have outperformed positions favored by hedge funds alone (+13%) or mutual funds alone (+12%). There are 13 stocks in our mutual fund overweight basket that overlap with key hedge fund long holdings, including: AMZN, FB, GOOGL, JPM, and MSFT.
Stocks out of favor with both mutual funds and hedge funds have trailed firms out of favor with one group alone. 20 constituents in our mutual fund underweight basket are also important hedge fund shorts position, including AMGN, F, GE, PG, and XOM (Exhibit 5 contains a table of overlap positions).