Hedge Funds Have Never Been More Concentrated Into The Same Handful Of Stocks

Six years ago, we presented what we then viewed (and still view) as the best trading strategy of the New Abnormal period, when we said that buying the most shorted names while shorting the names that have the highest hedge fund concentration and institutional ownership is the surest way to generate alpha, to wit:

"... in a world in which nothing has changed from a year ago, and where fundamentals still don't matter, what is one to do to generate an outside market return? Simple: more of the same and punish those who still believe in an efficient, capital-allocating marketplace and keep bidding up the most shorted names."

Following this initial observation, we would periodically urge readers to keep doing this simple trade year after year, which repeatedly proved to be the best source of alpha in a market that has become infatuated with beta, as none other than Bank of America confirmed in late 2019 when it showed that going long the most shorted names and shorting the most popular ones has continued to be not only the most consistently profitable, alpha-generating strategy, but that in 2019, the top 10 crowded stocks underperformed the 10 most neglected stocks by 23%; the most on record!

The topic of high investor concentration also dominated the latest hedge fund monitor report from Goldman Sachs, which, once every quarter, summarizes the bank's take on hedge fund positioning based on 13F reports.

Not surprisingly, what it found is that, as the coronavirus pandemic sparked a 34% plunge in US equities - before the Fed stepped in - hedge funds, scrambling to protect against further losses, concentrated their portfolios even further into their favorite growth stocks.

This happened even as HF tilts to growth stocks and defensive industries were large coming into 2020, and at the start of 2Q, rivaled the most extreme levels on record.

In fact, according to Goldman, the two stocks with the largest increase in hedge fund popularity in 1Q – AMZN and MSFT – already ranked among the top stocks in our VIP list of the most popular hedge fund long positions. This represents the seventh consecutive quarter with the same top 5 VIPs. AMZN has topped the list in 5 of the last 6 quarters.

In other words, if something eventually does happen to the FAAMGs - and Goldman is on the record warning that sooner or later there will be a painful repricing of these stocks that now account for 21% of the S&P's market cap - the entire hedge fund industry will blow up.

And speaking of hedge fund performance, it will come as a shock to nobody that according to the HFR equity hedge fund index, the S&P500 and the broadest tracker of equity hedge fund performance are virtually neck and neck YTD, with the one highlight that one doesn't pay 2 and 20 to buy the SPY; which as we have repeatedly pointed out over the years, is now explicitly micromanaged by the Federal Reserve itself, once again begging the question: what's the point of hedging when central banks will not allow any sustained drop?

Of course, loathe to give up on all those millions in management and underperformance fees, the hedging continues; and what happened in the first quarter is a narrative with two key parts: i) hedge funds got slammed by being overly concentrated in the same handful of stocks with adverse performance from all but the biggest megacaps detracting from overall HF P&L, and ii) the outperformance of just the five biggest stocks, the FAAMGs (a topic extensively covered here) offsetting the underperformance of everything else.

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