Hedge funds are partying like its 1999, boosting their use of leverage to levels not seen since before the financial crisis and betting heavily on popular technology and internet stocks, according to Goldman Sachs Hedge Fund Trend Monitor report.
The so-called FAANG stocks Facebook, Amazon, Apple, Netflix, and Googles parent company Alphabet ranked at the top of Goldmans Hedge Fund VIP basket, a set of 50 stocks that appear most often among the top-ten holdings of hedge fund portfolios, and helped the basket outperform the Standard & Poors 500 stock index by three percentage points, with the Goldman basket earning 10 percent year-to-date compared with the stock indexs 7 percent gain. The average equity hedge fund returned 4 percent as of May 19, Goldman said in its report, which examined 821 hedge funds with $1.9 trillion of gross equity positions.
Hedge fund gross exposure levels (the sum total of long and short exposures) have reached to 230 percent about the same as the post-crisis high set in 2013 while net leverage has surged 73 percent, well above any levels in recent years, the report stated. Meanwhile, the S&P 500 has reached record highs, and short interest as a percent of S&P 500 market cap remains near five-year lows, according to the report. That leverage, combined with hedge funds boosting their investments in high-octane growth stocks that have risen sharply in recent months, has contributed significantly to many hedge fund long portfolios, Goldman said.
The top-three stocks on the VIP list Facebook, Amazon, and Alphabet are each held as a top-ten portfolio position in more than 60 hedge funds, the report found. Facebook is the mostly widely owned stock among hedge funds, with 79 funds holding the company as a top-ten position, even as the social media network reckoned with several crises this year, including violent acts broadcasted on its Facebook Live service. Facebook and Amazon have each posted a 28 percent return year-to-date.
Hedge funds remain heavily invested in the perennial favorites of information technology and consumer discretionary stocks, Goldman said, with information technologys average long weighting rising by 141 basis points (or 1.41 percentage points) over last quarter, the largest increase among the sectors. Consumer discretionary posted a 45-basis point increase over the quarter.
FAANG stocks have had a somewhat negative connotation due to their high proportion of index returns, said Stanley Altshuller, co-founder and chief research officer for Novus Partners, a platform for investment managers. For example, among the S&P 1500 stocks, only 28 stocks, including FAANG, accounted for a whopping half of the indexs returns in 2015, the lowest number of stocks to contribute such a substantial proportion of returns since 2008. This indicates low market breadth, Altshuller said, with the high-flying stocks disguising the fact that most stocks did not post gains for the year. Market breadth has since rebounded in 2016 to a more normal level of about 60 stocks comprising half of returns, he noted.
When market breadth is low, hedge funds simply go to the few stocks where alpha can be found, Altshuller said. Now that breadth has widened, he sees a return to fundamentals as managers examine their investment thesis for each company.
Overall, Altshuller said he thinks several factors are playing to hedge funds advantage along with current market breadth, including increasing dispersion among stock returns, which allows managers more room to beat the index. Together, theres enough opportunity out there for hedge funds to make money again, he said, adding, Its looking to be a more favorable investment environment, and not just for hedge funds.