In what has started off as another woeful quarter for hedge funds, with equity hedge funds generating the worst YTD return of all asset classes tracked by Goldman - at 0% - and the composite Hedge Fund Index returning just 1%, ostensibly due to squeezed short books which have caused some major pain in the past 6 weeks...
... hedge funds can thank retail investors for what is at least solid outperformance of the long books as tracked by Goldman's "Hedge Fund VIP Basket", which is up 9% YTD, just shy of the Nasdaq's 10Y return, largely thanks to the great prepondrence of tech stocks in the VIP list. As Goldman writes:
During the last few months, the most popular hedge fund positions have enjoyed one of their strongest rallies on record. Our Hedge Fund VIP basket, which tracks the most popular hedge fund long positions (ticker: GSTHHVIP), has returned 24% since the start of 4Q 2019, sharply outperforming both the S&P 500 (+14%) and our basket of the largest short positions (GSTHVISP, +8%). The basket’s return relative to its realized volatility and its outperformance versus the largest shorts each rank as the strongest in the basket’s history. The outperformance of VIPs has continued in early 2020 (+9% YTD), contributing to a 1% YTD return for the average hedge fund.
How does retail play into this? Goldman explains:
The most popular hedge fund stocks have also been bolstered by a surge in retail trading activity. The sharp increase in retail trading has lifted a basket of popular retail stocks (GSXURFAV) by 14% YTD and 25% since the start of 4Q 2019.
And since many favorite retail stocks are also popular with hedge funds, the retail trading surge has also benefited the performance of hedge fund long portfolios (and yes, retail investors are now outperforming hedge funds). Of the top 20 stocks in Goldman Hedge Fund VIP basket, 13 also rank among the 50 most popular retail trading stocks, including the VIP basket’s top three constituents (AMZN, FB, MSFT). And as the convergence between hedge funds and retail investors continues apace, three of this quarter’s new Hedge Fund VIPs also rank among the most popular retail trading stocks (TSLA, UBER, BA). One wonders how until hedge funds pay retail investors 2 and 20 for the privilege of piggybacking on their "investment ideas."
Unable to keep a long-only book - as otherwise they wouldn't be "hedging" and would be far less compensated "vanilla funds" - hedge funds find themselves forced to kick up the beta ever more, which means using ever more leverage, something which can be seen in the chart below. That said, in Q4, hedge fund portfolio concentration declined modestly in 4Q, the long-term trend is clearly toward more concentrated portfolios and the surge in broad equity market concentration. As a result, the typical hedge fund holds 69% of its long portfolio in its top 10 positions, up from 55% in 2005 but down from 72% at the start of 2019. That, however, has been somewhat offset by the sharp increase in concentration across the total US equity market. The 10 largest companies now account for 25% of S&P 500 market cap, the highest share in nearly 20 years.
And while we will have more to say on the relative performance of hedge funds in a subsequent post, let's take a look at the one thing that really mattered so far in 2020: the handful or so stocks that make up the bulk of the top holdings of both hedge fund and retail investors: the Hedge Fund VIP list.
As Goldman explains, its Hedge Fund VIP List contains the top long positions of fundamentally-driven hedge funds. These “stocks that matter most” are the positions that appear most frequently among the top 10 holdings within hedge fund portfolios. From an implementation standpoint, the Hedge Fund VIP list represents a tool for investors seeking to “follow the smart money” based on 13-F filings. By construction, the VIP list identifies the 50 stocks whose performance will largely influence the long side of many fundamentally driven hedge funds.
The Hedge Fund VIP basket has outperformed the S&P 500 by 451 bp YTD (+9% vs. +5%) and has outperformed the S&P 500 in 60% of quarters since 2001. The basket has been a strong historical performer, but suffered volatility in 2019. The basket outperformed the S&P 500 by 425 bp through April, lagged by 870 bp through September as recession fears and trade tensions grew, and outperformed the S&P 500 by 500 bp during 4Q alongside the market rally.
Finally, the Hedge Fund VIP basket is not sector-neutral to the S&P 500. The VIP list contains stocks from 7 of the 11 sectors, with Real Estate, Consumer Staples, Materials, and Energy absent. Information Technology (36%) represents the largest weight in the basket.
And so, without further ado, here is the list of the 50 stocks that matter the most to hedge funds, i.e, the VIP list. Predictably, it is headed by tech darlings such as Amazon, Facebook, Microsoft, Alphabet, Alibaba and Netflix. As a side note, Q4 was the 6th consecutive quarter that saw the same 6 tech stocks in the "top 10" of this list:
And while the GS VIP list is certainly notable, if only because everyone owns the same 50 or so top stocks, what we find far more fascinating, and a far better source of alpha, is the hedge fund top 50 most shorted - or hated - stocks, which as we have shown year after year tend to significantly outperform the market due to periodic and vicious short squeezes especially in this day and age when the link between fundamentals and asset prices has been terminally severed by central banks, something we described most recently in "Going Against The Wall Street Crowd Has Been The Most Profitable In 5 Years"