2018 was a year to forget for pretty much everyone with the possible exception of Ray Dalio’s “pretty stupid” cash holders who enjoyed some of the best relative performance for US T-bills in 120 years.
But as bad as it was for nearly all investors, last year was especially trying for equity hedge funds, which suffered mightily during the October drawdown when consensus Growth/Tech/Momentum longs careened lower leading to massive de-leveraging from the Long/Short universe.
By the time it was all said and done, 2018 was the worst year for equity hedge funds since 2011. We spilled gallons of digital ink late last year documenting that crowd’s Q4 trials and tribulations.
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Fast forward to February and generally speaking, exposure has yet to be rebuilt across various strategies, which to some observers suggests there’s considerable scope for the YTD bounce to run further as folks get “forced”/drawn in amid suppressed volatility and a steady grind higher in the benchmarks.
Long story short (and there’s a bad market pun in there), both the fundamental/ discretionary crowd and the systematic universe look to have generally remained on the sidelines, perhaps still shell-shocked from one of the more tumultuous stretches in recent memory.
In his latest note, JPMorgan’s Marko Kolanovic talked at length about the scope for mechanical re-leveraging/re-risking and Nomura’s Charlie McElligott has made similar arguments in multiple daily missives this month. Meanwhile, BofAML’s latest global fund manager survey described what the bank’s Michael Hartnett is calling a “big fat buyers’ strike“, perhaps underscoring the notion that there’s a lot of sideline money waiting to chase the rally.
That’s the backdrop for the latest installment of Goldman’s “Hedge Fund Trend Monitor” series, which finds the bank delivering some good news for an industry that hasn’t gotten much lately.
“The average equity hedge fund has returned 6% YTD, boosted by the strong performance of high conviction long positions”, the bank writes, adding that their vaunted VIP basket (comprised of the most popular long positions) has rallied 14% in 2019 while the Hedge Fund High Concentration basket (just stocks with the highest fund ownership as a share of cap) is up 17%, trouncing the S&P’s 11% gain.
(Goldman)
In addition to solid performance from the most popular longs, there are a couple of additional factors at play here, not the least of which is what Goldman says was a fortuitously timed decision to increase net length just ahead of the bottom late last year.
Specifically, the bank notes that “the relative performance of [the] Hedge Fund VIP basket and hedge fund net long exposure each bottomed in the days before the S&P 500 reached its low on December 24.” Goldman also says funds shifted out of defensives and into cyclicals just ahead of the bounce.
Meanwhile, gross exposure is still depressed, having yet to rebound after the plunge following the October rout. Funds look to have cut short positions prior to the market bounce, helping returns further. “Mirroring the decline in gross exposures, the share of S&P 500 market cap held short is now at the lowest level since 2007”, Goldman goes on to say, adding that “due in part to this reduction in short activity, the stocks with the highest ratio of short interest to float cap have outperformed in most sectors during the recent market rebound.”
(Goldman)
Also notable, concentration has literally never been higher, with the average fund holding some 70% of its long portfolio in just its top 10 positions (because nothing could go wrong with that).
(Goldman)
Oh, and turnover finally picked up in Q4 amid the widespread tumult. The trend in hedge fund portfolio turnover has been down for years, and you could argue that’s in part attributable to the fact that beating benchmarks has been well nigh impossible thanks to the dynamics that Howard Marks has variously characterized as a “perpetual motion machine”- but that’s another discussion.
Finally, for those interested, below find the updated list of hedge funds’ most important long positions followed by the most important short positions.
(Goldman)
How much of the “big fat buyer’s strike’ is a direct function of the unpredictable actions and demogogic rhetoric of the very unstable “genius” in the White House? Probably above their pay grade, but i’d love to hear Kolanovic and McElligott weigh in on that.
Looking at those lists it seems they long NDX vs. an adjusted short DJ (for instance they don’t dare to short Boeing). They believe in growth outperforming. Growth and outlook are more important than solid cash cows, emblematic is the long NFLX and short DIS.
They think the merge BMY+CELG isn’t going to be positive, both stocks are shorted.
Are Johnson and Johnson, Kraft, Deutsche Bank, et al going to cause any consternation in this market at all, especially with this hyper de-regulation Administration, or are they going to be treated as idiosyncrasies?
Are Johnson and Johnson, Kraft, Deutsche Bank, et al going to cause any consternation in this market, especially with this hyper de-regulation Administration, or will they be treated as idiosyncrasies?