When stock markets plummeted, hedge funds did what they could to protect themselves. Overall, the fund remains in the hold pattern — with the lowest equity exposure since 2009. This is undoubtedly good news for investors, as the 50 most popular long positions among hedge funds have declined year-to-date. However, the funds have also become anti-momentum, which has hurt their returns.
WASHINGTON, DC – OCTOBER 10: David Solomon, President and Co-COO of Goldman Sachs, speaks on stage… [+] Fortune Most Powerful Women Summit – Day 2, October 10, 2017 in Washington, DC. (Photo by Paul Morigi/Getty Images for Fortune)
Hedge funds limit equity exposure
In its quarterly hedge fund trend monitor, Goldman Sachs reported that the average hedge fund is down 5% year-to-date amid a challenging market for alpha and beta. Low exposure helped hedge funds limit beta headwinds from the S&P 500’s 16% year-to-date decline and the 29% decline in Goldman’s Hedge Fund VIP basket of the 50 most popular long positions among fundamental hedge funds.
The company said macro funds have generally outperformed stock funds, with a 9% year-to-date return compared to the average stock fund return of -12%.
Quarterly inter-fund position trading fell to a new low in the third quarter. The company noted that the overall magnitude of change in sector tilt was also the smallest since 2019, and that most tilts are around their 10-year average.
Goldman also noted that the balance between growth and value is back to the 20-year moving average, adding that funds are generally growth-biased. However, compared to the previous year, they are taking on more price risk than usual.
Growth’s outperformance in the third quarter helped the hedge fund return to its 20-year growth versus value moving average. In addition, despite their low market exposure, hedge fund long portfolios show unusually large deviations from momentum.
In the last 20 years, the current anti-momentum slope has only been breached twice in early 2002 and in the second quarter of 2022. Hedge funds typically tend to be momentum, but they have gradually reduced this position since the mid-2020s.
Goldman also noted that momentum has been highly negatively correlated with stock market direction lately, as evidenced by the market rally earlier this month and sharp reversal.
Therefore, it makes sense that momentum’s momentum served as a headwind for returns for much of this year, although it was rewarded during this month’s bullish momentum reversal. Goldman’s long/short S&P 500 Momentum Factor is down 20% this year through Nov. 3, but has since reversed sharply, with the reversal ranking in the first percentile since 1980.
The company found that Momentum has outperformed during other periods of market stress, including 2009, 2012, 2016 and 2020. As such, Goldman does not expect its recent outperformance to fully reverse without a material improvement in the market and economic outlook.
Decrease in net leverage
Meanwhile, net debt continued to decline as it did throughout the year. However, the firm said the overall risk is still surprisingly high given the challenge of picking winning stocks in the current environment.
Although net debt has increased over the past month, it remains well below its further five-year average. Gross debt was volatile but declined only slightly. Low net debt suggests that hedge funds are not optimistic about the near-term trajectory of the market, but their bias away from momentum is at odds with that prospect.
The fund used ETFs and futures to manage its exposure to a macro-driven, highly correlated market. The ratio of ETF to single stock short rates is now at its highest level in 10 years. In fact, short interest in individual stocks remains near record lows from 2000 and last year.
Hedge Fund VIP List
Although Goldman’s hedge fund VIP basket is down 29% year-to-date, hedge funds appear to be holding onto their favorite stocks. The average hedge fund has invested 71% of its long portfolio in its top 10 positions, the second-highest concentration since Q4 2018.
Technology and communications services make up almost half of Goldman’s VIP list and eight of the top 10 stocks. Although hedge funds restricted their remittances from Chinese ADRs in the third quarter, Alibaba remained the only representative on the VIP list.
The VIP Basket has outperformed the S&P 500 58% of the quarters since 2001 and has averaged an excess return of 34 basis points per quarter. However, the basket has underperformed this year, down 29% year to date and lagging the S&P 500 by 13 percentage points.
This year’s performance puts the VIP list on track to become the second-worst year of the last 20 years, after 2008 in absolute terms and after 2021 in relative terms. The VIP list has lagged since the beginning of 2021, although it has outperformed the market in third. Quarter. However, in recent weeks, Baskets has resumed its poor performance.
minimal range change
Sector allocations were relatively stable in the third quarter as most net sector allocations have been in the middle of their distributions over the last 10 years. Interestingly, the company noted that the biggest sector change was the shift from consumer discretionary to consumer staples. However, four of the top 10 names on VIP’s list of favorite hedge fund stocks are consumer discretionary names.
Industrials is still the largest net overweight versus the Russell 3000. However, only one stock, TransUnion TRU, rose to a spot on the company’s Rising Stars list with the biggest surge in popularity among hedge funds in the third quarter. Four industrialists have now been named to Goldman’s Falling Stars list: GXO Logistics, Robert Half International RHI, Johnson Controls International JCI and IAA.
The following is on the VIP list for Q3
In addition to being swayed by momentum, the hedge fund VIP list has recently turned away from quality factors, which include high return on investments and low volatility. The firm said the performance of its most popular long positions was more correlated with the outperformance of small-caps than large-caps.
Microsoft MSFT replaces Amazon AMZN as the hedge fund’s top stock, and Uber UBER and Netflix NFLX join the list to enter the top five. Meta Platforms fell out of the top 5 for the first time since 2014. There were 15 new additions to the VIP list in Q3, including NVIDIA NVDA DIA, Workday, VMware VMW, S&P Global, Liberty Media Series C and more. Eli Lilli.
Along with Microsoft, Amazon, Meta Platforms, Uber and Netflix, the other top 10 stocks were Alphabet, Visa V, Apple AAPL, Mastercard MA and PayPal PYPL. The top 10 worst performers to date are all in the red, with Meta Platforms (-65%), PayPal (-52%), Netflix (-49%) and Amazon (-41%). Only Visa (-2%) and Mastercard (-4%) posted negative single-digit returns.
Further down the list, T-Mobile (+25%), Willscott Mobile Mini Holdings (+14%) and Activision Blizzard ATV (+12%) all outperformed the rest of the list. Some notable strong performers include Chesapeake Energy CHK (+71%), Energy Transfer LP Unit (+58%) and Eli Lilly (+30%). However, they were way down the list of VIPs, suggesting they are much less popular than many of the positions dropped this year.