What Current Hedge Fund Exposure Means For Stocks, And Weekly Chartology

Tyler Durden's picture

Yesterday we presented the latest 13F quarterly compilation summary, as prepared by Goldman's David Kostin, in raw format. Today, we bring you his high level observations on what this update means for stocks from a big picture perspective, as well as thematically. "We estimate hedge funds own roughly 3% of the US equity market. Turnover of all hedge fund positions averaged 32% during 1Q 2011 (roughly 130% annualized). The tilt of hedge fund holdings towards large-cap stocks has been increasing for almost 10 years. The typical hedge fund operates 48% net long, flat versus 4Q 2010. Combining long and short position data, hedge funds have the greatest net portfolio exposure to Consumer Discretionary (18%), Information Technology (16%), and Energy (14%). Our Hedge Fund VIP basket has 15 new constituents: SSCC, BP, MRO, PCLN, VRX, TEVA, YHOO, CVX, MET, NFLX, MA, SINA, CHK, EQIX, and ESV." In addition, for all you technicians, here is the full weekly chartporn from GS.

Full details:

Our most recent Hedge Fund Trend Monitor report analyzed 700 hedge funds with $1.25 trillion of gross equity positions consisting of $822 billion of long stock-specific and ETF equity assets and an estimated $428 billion of short single-stock and ETF positions. We have published our quarterly Hedge Fund Trend Monitor for the past five years and analyzed constituent-level portfolio holdings of US hedge funds since 2001. The current report focuses on hedge fund positions at the start of 2Q 2011 and is based on 13-F filings as of May 15, 2011.

1. We estimate hedge funds own roughly 3% of the US equity market
. For context, US households directly own 33% of the domestic equity market, and indirectly own via mutual funds 21% of the stock market. ETFs account for 4% of the US stock market, slightly more than hedge funds.

2. Turnover of all hedge fund positions averaged 32% during 1Q 2011, representing an annualized rate of nearly 130%. The top quartile of positions (largest holdings) turned over just 18% (72% annualized) while the bottom-quartile of positions (smallest holdings) turned over 45% (180% annualized). Quarterly turnover at the sector-level ranged from a low of 29% in Telecom Services to a high of 37% in Materials (see Exhibit 1).

3. The tilt of aggregate hedge fund holdings towards large-cap stocks has been trending higher for almost 10 years. Roughly 47% of the aggregate assets of hedge funds was invested in stocks with equity capitalizations greater than $10 billion as of 1Q 2011, up from 35% in 2002. Just 19% of aggregate assets are invested in small-cap stocks (below $2 billion). The typical hedge fund allocates 36% of its assets to large-cap stocks ($10+ billion) and 33% to small-cap stocks. The difference between the average and aggregate suggests that the hedge funds with the largest assets under management target large-cap stocks (see Exhibit 2).

4. The typical hedge fund operates 48% net long ($394 billion net/$822 billion long), flat versus 4Q 2010.
We estimate 18% of short positioning is conducted via ETFs with 13% occurring at the broad index level.

5. We estimate hedge funds account for 85% of all short positions. The steady growth of shorts in the US equity market during the past nine years has accompanied the rise in hedge fund assets. Short interest for the S&P 500 rose during most of 2010 before falling in 4Q 2010 and 1Q 2011. Currently 1.9% of equity cap is held short, while the short interest ratio has declined but is above 10-year low reached in late 2009.

6. Combining long and short position data, hedge funds have the greatest net portfolio exposure to Consumer Discretionary (18.3%), Information Technology (15.5%), and Energy (14.0%).
Hedge funds are not benchmarked but relative to the Russell 3000 universe they are 670 bp overweight Consumer Discretionary (18.3% vs. 11.6%), and 640 bp underweight Consumer Staples (3.1% vs. 9.5%).

7. The strategy of buying the 20 most concentrated stocks has a strong track record over more than nine years.
We define “concentration” as the share of market capitalization owned in aggregate by hedge funds. Since 2001, the strategy has outperformed the market 73% of the time by an average of 295 bp per quarter (not annualized). The back test suggests that this strategy works in an upward trending market but tends to perform poorly during choppy or flat markets. The “most concentrated” hedge fund ownership basket has outperformed the S&P 500 in 2011 YTD by 502 bp (10.3% vs. 5.2%). See Bloomberg ticker: <GSTHHFHI>.

8. Hedge fund returns are highly dependent on the performance of a few key stocks. The typical hedge fund has an average of 64% of its long equity assets invested in its 10 largest positions compared with 29% for the typical large-cap mutual fund, 19% for a small-cap mutual fund, 18% for the S&P 500 and just 3% for the Russell 2000 index (see Exhibit 3).

9. Our Hedge Fund VIP list (Bloomberg ticker: <GSTHHVIP>) contains the 50 stocks that appear most frequently among the top 10 holdings of fundamentally-driven hedge fund portfolios.
The basket of stocks that “matter most” has outperformed the S&P 500 by 68 bp on a quarterly basis since 2001, with a Sharpe Ratio of 0.25. However, the VIP list has lagged the S&P 500 YTD by 96 bp (4.8% vs. 5.8%). AAPL, MSFT, JPM, GOOG, and C rank as the top five stocks in our Hedge Fund VIP list (see Exhibit 4).

10. Turnover for the VIP basket was slightly below the historical average with 15 new stocks entering the VIP list compared with an average turnover of 16 stocks since 2001
. New constituents: SSCC, BP, MRO, PCLN, VRX, TEVA, YHOO, CVX, MET, NFLX, MA, SINA, CHK, EQIX, and ESV.

From an implementation standpoint, the hedge fund VIP list offers an efficient vehicle for investors seeking to “follow the smart money” based on 13-F filings. The VIP basket has a large cap bias with a median market capitalization of $37 billion compared with $12 billion for the S&P 500. The VIP list contains stocks from seven of the ten sectors.

Summarized in one sentence: "Feel free to collect pennies in front of a steamroller as long as everyone else is doing it." What is left out is "If SHTF Bernanke may or may not bail everyone out this time around." What is certainly not included is: "since there is great career risk if you think like a contrarian, best leave it to someone else, as the black swan trade no longer exists." Of course, the last is completely wrong, and for a summary of the best ones look no further than SocGen's Dylan Grice.

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