While Hedge Funds Underperformed The S&P By 80% In 2013, They Piled Into These Three Stocks

That hedge funds as a whole have been underperforming the S&P500 not only in 2013 but in the past five years is well-known to most. This trend continued into the second half when, as Goldman calculates, the average hedge fund has returned only 4.1%, or an 80% underperformance compared to the S&P500's 20% through August 9. This is a marked deterioration compared to the 65% underperformance the last time we made this comparative observation in May.

Goldman's summary take is as follows:

Key hedge fund long positions are beating the market by an average of 300 bp.


The typical hedge fund generated a 2013 YTD return of 4% through August 9, compared with 20% gains for both the S&P 500 and the average large-cap core mutual fund. Last year the average hedge fund returned 8% versus 16% for the S&P 500.


The distribution of YTD performance suggests that 25% of hedge funds have generated absolute losses. The standard deviation of YTD hedge fund returns has widened to 8 percentage points from roughly 6 percentage points at the start of 2Q. While almost 60% of funds has generated returns above the 4% average, fewer than 5% of hedge funds has outperformed the S&P 500 or the average large-cap core mutual fund YTD. The distribution of macro funds is especially wide, with YTD returns ranging from -24% to 15%.

A big factor for the accelerating underperformance is that as the market ramped much higher in Q2 and July, hedge funds were building up short positions.

As Goldman notes, just as there are hedge fund long "hotels", so there are shorts. And it is here where the managers have piled in, and where short squeeze after short squeeze has caused the bulk of the underperformance:

Unfortunately, many widely-held short positions continue to outperform, offsetting the strong performance of popular longs and hampering overall hedge fund returns. Our basket of S&P 500 stocks with the largest dollars of shorts (<GSTHVISP>) has returned 20% YTD, in line with the S&P 500. In addition, the 50 stocks over $1 billion market cap with the highest short interest as a percentage of market cap returned an average of 30%. Fully 12 of the 50 key short positions have returned more than three times the S&P 500 return.


And as is clear from the chart below, 'most shorted' names have dramatically outperformed the S&P; not exactly providing the strong foundation upon which to build a next leg higher in stocks. Incidentally, it was a year ago when we said that anyone who wishes to outperform the S&P, either outright or in a pair trade, should simply go long the most shorted names.

Well, with Chief Market Risk Manager Bernanke at the helm making sure there is no risk, ever again, only lunatics will short right? Well, yes: until Ben pulls the rug from underneath everyone. Then the last will be first.

And the first will be last.

Because just as there are popular hedge fund shorts, so there are the proverbial long hedge fund hotel (Californias). And while AAPL is no longer the market's darling (as of June 30 it was only second in popularity with 174 hedge funds holding it), anyone who enters the highlighted top three names in the "most held" chart below better be ready to get out ahead of everyone or be the last bagholder standing if and when thing turn around.


So... 2 and 20 anyone?


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