A little over a month ahead of 13F season, BofA has analyzed hedge fund long and short portfolios to come up with a snapshot representation of the most popular and most hated positions, as well as a broad distribution of holdings by sectors. Here is a snapshot of the findings.
Hedge funds’ gross positioning is most aggressive in Discretionary, which is the fourth-biggest sector in the S&P 500 index, accounting for less than half of Tech’s weight, but hedge funds have taken the second-biggest gross long and short exposure in the sector after Tech. In particular, their short exposure in Discretionary is the same size as their short exposure within Tech.
Next, net exposure: BofA calculates the net exposure of hedge funds (HFs) by subtracting estimated short positions from their reported long positions. Based on the net exposure, hedge funds are most overweight Materials (1.89x), Discretionary (1.47x) and Health Care (1.28x), while maintaining a net short exposure to Telecom
What is surprising here is that contrary to widespread "knowledge", hedge funds are not massively net long tech. So what explains the tremendous outperformance of tech stocks in recent months? Simple: as BofA showed previously, much of the ascent in tech names in the first half is due to tech company stock repurchases, or as BofA said "net buying of Tech in the 1H was entirely buyback-driven." It begs the question what will happen when buybacks stop (either due to the earnings blackout period or for another reason), or merely slowdown as corporate cash levels decline.
Tech "mystery" notwithstanding, here is the most important data breakdown: which are the S&P500 stocks with the highest and lowest net relative exposure (on the long side), and alternatively, which are the most, and least, shorted stocks.
The two tables below are screens of stocks with the most (Table 3) and the least (Table 4) short interest (as a % of float), where, the bank estimates that most (~85%) of short interest in stocks is from hedge funds.
According to the above data, traders who are betting on a continuation of the historic short squeeze that hit in mid June would be well advised to go long the most shorted names and hedge by shorting the least shorted names.
Next, BofA also has a screen of stocks which are most overweight by hedge funds based on their net relative weight in the stocks vs. its weight in the S&P 500 (Table 5), and 2) a screen of stocks which have the largest net short positioning by hedge funds relative to the stocks’ weight in the S&P 500 (Table 6). In other words, these are the stocks that hedge funds love most and least, but not enough to necessarily short them, even though the list of "Bottom 20" names roughly coincides with the 20 most shorted names.
Why does the above data matter and why is positioning relevant?
Simple: as we first explained back in 2013 in "For The Third Year In A Row, The "Most Shorted Names" Generate The Highest Return" and also in
"Presenting The Best Trading Strategy Over The Past Year: Why Buying The Most Hated Names Continues To Generate "Alpha", going long the most hated/shorted names, while shorting the most popular/beloved stocks has been a winning strategy virtually every year since the financial crisis, largely thanks to central banks turning the market upside down.
BofA confirms as much writing that "Over the last several years, buying the most underweight stocks by large cap active funds and selling the most overweight stocks by large cap active funds has consistently generated alpha" and while the performance of this strategy in 2017 was sketchy, the trade more than redeemed itself in June when the most shorted names enjoyed a historic outperformance relative to the broader market.
Finally, BofA makes a notable caveat highlighting that positioning risks are particularly acute during quarter-end rebalancing: the 10 most neglected stocks have outperformed the 10 most crowded stocks by an annualized spread of 90ppt on average during the first 15 days of each quarter since 2012.
In retrospect, if only David Einhorn had followed this simple strategy over the past 5 years, he would probably be the single best performing hedge fund in the world right now, instead of watching his legacy disappear with one redemption request after another.