Ok, so one thing we and others have noted on countless occasions this year is that it’s starting to seem more and more like hedge funds have thrown in the proverbial towel on outperforming benchmarks in an era where those benchmarks are levitated inexorably higher on the back of central bank liquidity and outperformance by a handful of high-flying tech names.
In short: if you can’t beat ’em (where “’em” are the hordes of retail investors riding the FANG and central bank waves by simply buying QQQ and SPY and waiting around for E*Trade to deposit their yacht money), join ’em. And with leverage.
Sure enough, the latest hedge fund monitor piece from Goldman confirms the above assessment.
Consider this, for instance:
The most popular equity long positions have outperformed both the broad market and the largest shorts so far in 2017, driving the strongest start to the year for equity hedge funds since 2009. Equity hedge funds have returned 7%YTD as our Hedge Fund VIP basket of most popular stocks outperformed the S&P 500 by 725 bp (19% vs. 12%). At this point in the year, equity hedge funds are on pace for their best returns since 2009, when they posted a 16% gain in the first seven months of the year.
Really, all you need is that chart. Because it shows that while hedge funds in general and even equity hedge funds as a group still can’t beat the S&P, Goldman’s hedge fund VIP basket has outperformed by a full 7%. A fact which leads us directly to this bit from the same Goldman note:
After lagging in late 2015 and early 2016, Hedge Fund VIPs have 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%). 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%).
Simply put, they’re just levering up on the names that are working, because that’s the only thing you can do to beat benchmarks that never fall in an environment of artificially suppressed vol. Here’s a bit more:
Fund performance this year is particularly notable in the context of historically low levels of volatility and return dispersion. Realized and implied volatility have approached record lows in equities and across asset classes. The environment of low dispersion and volatility, combined with low correlations and the strong performance of hedge fund favorite stocks and sectors, supports the approach of high leverage and low position turnover that has benefited fund returns so far this year.
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.
This “density” has risen steadily for two years, from 18% to 21%, but now sits near the average level since 1990.
Of course that “average” includes the dot-com bubble, so you know, take that into consideration.
Turnover ticked a bit higher in Q2, but is still trending lower, underscoring (and likely perpetuating) the low vol. regime and suggesting (again) that a “can’t beat ’em, join ’em” dynamic is at play:
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“It’s all one trade!!!”
