With cross-asset correlation plunging and stock dispersion soaring...
... conventional wisdom on the street predicted that after 7 years of underperformance, 2017 would finally be the year in which hedge funds demonstrated why they are paid 2 and 20.
Alas, it was not meant to be becauase as Goldman reports in is quarterly hedge fund Trend Monitor report, six weeks into the year, the strong equity market has lifted the average hedge fund to just a 2% return YTD, once again underperforming the broader market YTD by more than 50%, while macro funds have generated a 0% return YTD. That said, not everyone is sucking, and the typical equity long/short hedge funds has fared relatively better (+4%), boosted however not so much by "stock picking", but due to near record leverage.
While once upon a time hedge funds actually generated alpha, the story from the past several years has been all about levered beta. The first 6 weeks of 2017 are no different. That, and apparently providing value through aggressive purchases of ETFs. From Goldman:
Funds benefitted from the decision to lift net long exposures before the election, and have continued to increase leverage during the subsequent 10% equity market rally. The Goldman Sachs Prime Services Weekly shows that hedge fund net exposure rose from 53% in September 2016 to 59% on Election Day, and has since surged to nearly 70%, the highest since 2015. Hopes for better economic growth, lower taxes, and other policy tailwinds to corporate earnings also led funds to cut short interest as a share of S&P 500 market cap to the lowest level since 2012, while adding market beta through ETFs.
Net exposure has soared...
... while shorts have tumbled at the expense of the highest ETF exposure since 2013. Because surely LPs can't buy ETFs on their own.
Another observation: after years of collapsing turnover, in Q4 hedge funds at least put in a token effort to rebalance:
Hedge fund position turnover rose to 29% during 4Q 2016, following a record low in 3Q 2016. However, turnover of the largest quartile of hedge fund positions, which account for two-thirds of hedge fund long holdings, fell to 14%. Turnover increased most in the Utilities, Consumer Discretionary, and Consumer Staples sectors.
Unfortunately for hedge funds, they once again appear to have rotated in all the wrong names:
Stocks with high hedge fund concentration unusually weak YTD
Our basket of the 20 “Most Concentrated” stocks (ticker: <GSTHHFHI>) has lagged the S&P 500 by 300 bp YTD (2% vs. 5%), an unusual stretch after leading the S&P 500 by an average of 900 bp in each of the last five years. Since 2001 the strategy of owning the stocks with the largest share of equity cap held by hedge funds has outperformed the S&P 500 during 67% of quarters by an average of 236 bp per quarter.
One almost wonders if hedge funds were not terrified of coming up with their own, original ideas, then perhaps they could get back to doing what they are paid to do: generating alpha. Since that remains impossible, for their copycat amusement here is Goldman's best idea how to stand out from the just as useless crowd:
Hedge funds should consider the alpha-generation potential – as either long positions or shorts – of the under-owned stocks listed below. These 17 companies fall within the top 20% of S&P 500 firms based on our Dispersion Score framework, a measure of the extent to which micro factors, rather than macro dynamics, are likely to drive returns. These stocks also have less than 5% of market cap owned by hedge funds, outstanding short interest accounting for less than 5% of market cap, and five or fewer hedge funds owning each stock as a top 10 portfolio position.