Hit to hedge fund longs leaves just 11% of industry beating sharemarket

Only about one in every 10 hedge funds was beating the S&P 500 index by July, after managers’ top long positions fell twice as sharply as the benchmark’s own decline last quarter, according to analysis by Goldman Sachs.

The 50 long positions fundamental managers cited most frequently among their top 10 positions, in regulatory filings for 30 June, fell by 7.2% over the preceding three months.

By contrast, the S&P 500 fell by 2.8%, according to analysis the US bank published at the start of last week.

Partly as a result of this underperformance, only 11% of hedge funds were beating that index this year to July.

This was less than half the proportion (26%) that ended up beating it over the full 2011 calendar year.

The average hedge fund’s 5% gain to 3 August is under half the size of the S&P 500’s 12% rise.

Additionally, the typical hedge fund’s returns are only half those of the average large cap mutual fund this year, and one in every five hedge funds had not yet yielded a profit by August, according to the bank’s analysis of 699 hedge with $1.2trn gross assets.

While the average hedge fund stock picker has clearly sharply undershot US markets so far this year, the 50 ‘long stocks’ most often cited by managers among their top 10 holdings got closer, making 9% this year.

A glance through the list of hedge funds’ 50 favourite long holdings – as ranked by number of funds listing the company among their top 10 – shows only two stocks made under 10% this year (Google and Johnson & Johnson), while six made over 20% (Apple, Express Scripts Holding Co, priceline.com, American Intl Group, Liberty Media Corp and Amazon.com).

The regularly updated ‘long stock’ basket has still outperformed the S&P 500 by 54 basis points on a quarterly basis since 2001, with a Sharpe ratio of 0.21.

This year, a basket of stocks with the highest total US-dollar value of short interest made 12%, matching the index and beating hedge funds’ top 50 longs.

Managers are taking a guarded approach to markets this quarter, with net exposure at only 43%, down from 49% over the second quarter. The latest reading sat between the recent low of 36% posted in the third quarter of 2011, and the all-time high of 52%, in 2007.

Managers were overweight consumer discretionary (24%) and underweight consumer staples (4%) relative to the broad market index.

Rather than looking simply at overweights and underweights, however, investors seeking to replicate the successes of hedge funds may care to focus instead on the 20 shares with the highest share of their market capitalization owned by hedge funds.

Buying these stocks since 2001 has led to outperformance of the market 67% of the time, by an average of 2.53% per quarter, not annualized.

Goldman Sachs notes: “The stocks in the basket tend to be mid-caps at the lower end of the S&P 500 capitalization distribution, which have outperformed large-caps from 2004 to 2007, contributing to the attractive backtest results.”

The stocks with the ‘most concentrated’ hedge fund ownership also outperformed the S&P 500 this year to 15 August by 3.18%, making 16.5% versus the market’s 13.3%.

Goldman Sachs’ analysis also suggests hedge fund managers are highly reliant on relatively few long positions, with the average fund feeding over two thirds (64%) of its total long equity assets into just 10 top holdings.

This is almost double the comparable measure (36%) for large-cap mutual funds, and also comfortably higher than 18% for small cap funds, 21% for the S&P 500 itself, and just 2% for the Russell 2000 index.


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