What did everyone learn from the Facebook debacle this week?
Probably not a whole lot, would be my best guess. The better question would be this: what should everyone have learned from Facebook’s historic plunge?
What everyone should have learned from that episode is that crowded trades are perilous and, in the same vein, that the time to worry is when everyone thinks nothing can possibly go wrong.
There’s nothing particularly novel about either of those (related) observations and indeed they’re basically just different ways of stating that old Buffett quotable about “being fearful when others are greedy.” God knows I hate amorphous aphorisms that could just as easily apply to crossing the street as they could to investing, but when it comes to the FAANG contingent, the overcrowding and sure-footedness (despite the lack of space for any more feet on the ledge) bordered on the absurd and assuming there wasn’t an across-the-board cleanout this week, probably still does.
One of things documented extensively in the linked post above is how hedge funds were all-in on Facebook thanks at least in part to the whole “buyers’ strike” dynamic described last October by Wells Fargo. Tech highfliers are being driven inexorably higher by a self-feeding loop that optimizes around itself thanks to flows into passive investing vehicles that track the cap-weighted indexes which are dominated by these names. That’s supercharged by the proliferation of those stocks in smart-beta products.
That self-referential dynamic means it’s hard to generate any alpha, so instead, some active managers have just thrown in the towel and piled into the winners. Recall this from Goldman’s most recent hedge fund monitor, dated May 18:
Funds maintain conviction in their top positions. Hedge fund portfolio turnover remained near record lows during the volatile 1Q. The average fund carries 68% of its long portfolio in its top 10 positions, nearly an all-time high. Nine of the top 10 stocks in our VIP list last quarter remain in the top 10 this quarter. FB, which ranked as #2 last quarter, experienced the largest net increase in popularity among all stocks during 1Q. AAPL, AMZN, GOOGL, and NFLX ranked among the stocks with the largest decreases in popularity, but remain near the top of the VIP list.
That appeared to suggest that some folks had a really bad day on Thursday and Goldman is out with a new note that seeks to dispel what they say is a popular misconception about mutual funds and FAANGS.
The bank starts off by stating the obvious, which is this:
The 19% dive in FB’s stock price hurt hedge fund returns and our VIP basket given that it appears most often as a top 10 position across our analyzed universe of US hedge funds with 10 to 200 individual equity positions. Facebook is the most popular stock across US equity hedge funds. 222 hedge funds (26% of our total sample) owned FB as of the most recent 13-F filings. The average weight of FB in those portfolios was 4%. In addition, 97 hedge funds owning a total of $215 billion of equity assets held FB as a top 10 portfolio position, making it the top stock in our hedge fund VIP basket. The equal-weighted basket lagged the S&P 500 by 20 bp on Thursday.
But what about mutual funds? You might be surprised.
As Goldman goes on to write, “most investors believe that mutual funds are overweight the popular FANG stocks, when in fact the opposite is true.”
So what are the numbers on Facebook? Well, “the average large-cap mutual fund is underweight FB by 20 bp versus its benchmark,” Goldman says, which means that “FB added around 4 bp of alpha to the average large-cap mutual fund.”
So there. Take that hedge funds.
David Tepper (who owns 6.21m shares of Facebook) didn’t seem to care, though. He spent the day riding around in a golf cart talking about scrambled eggs and celebrating the fact that he just bought an NFL team with some of the money he freed up by liquidating his Apple stake.
— Carolina Panthers (@Panthers) July 26, 2018