Good times are here again for hedge funds maybe. New research from Goldman Sachs shows that equity hedge funds are off to a solid start to 2017. But a look at data collected by the investment bank shows how theyve done it: by going long and leveraging up.
The investment banks latest Hedge Fund Trend Monitor, which tracks the performance of these fund managers as well as their favorite stock picks, shows that while the average hedge fund has returned 2 percent through the third week of February, equity hedge funds have gained 4 percent over the same period. A basket of hedge funds favorite stock picks tracked by Goldman which the investment bank refers to as its Hedge Fund VIP Basket has fared even better, up 7 percent, compared with a 5 percent return for the Standard & Poors 500 stock index.
Hedge funds have made their money in large part by cranking up their exposure to stocks and juicing those returns with leverage. Goldmans report, published earlier this week, shows that net exposures have risen from 53 percent on average in September to 70 percent today, the highest net exposure since 2015. Meanwhile gross leverage has risen in recent months to 222 percent, near multi-year highs, according to the bank. Shorting has fallen out of favor in the sustained bull market, with short interest as a percentage of the S&P 500s market cap falling to 1.9 percent, its lowest level since 2012.
There is some good news for fundamentally- focused hedge funds, which have for years been complaining that high correlations mean that skilled stock-picking is not valued by the markets. Goldman finds that stock correlations have plummeted in the post U.S. election environment, with three-month S&P 500 realized average stock correlations falling to 0.09 percent earlier in February. That, according to Goldman, is the lowest level since the mid-1990s.
Before the so-called Tiger Cubs those famous hedge fund manager descendants of Julian Robertson Jr.s Tiger Management and other stock pickers start partying like its 1995, however, they might heed Goldmans point that correlations within sectors have declined less than the correlations between sectors, reflecting the relatively macro potential consequences of the new administrations promised policies and recent economic acceleration as well as the investor use of ETFs to capture those dynamics. In other words, sectors matter more than stocks.
Among the sectors still enjoying the so-called Trump bump, Goldman sees a slight, but not significant, overweight to large-cap financials among the most popular hedge fund holdings. The top hedge fund holdings, however, continue to be technology stocks, with 98 funds in Goldmans universe holding Google parent Alphabet, 92 owing Facebook, and 81 owing Amazon the top one, two and three most popular hedge fund stocks respectively. Apple, a perennial hedge fund favorite, has dropped to the sixth-most-popular spot.
Goldman also points out that while hedge fund portfolio concentration has declined, it remains at almost record highs, with the typical hedge fund having as much as 67 percent of its long-equity assets invested in its ten largest positions. Fund managers better hope those best ideas keep panning out if they want 2017 to be the year of the hedge fund comeback.