In the aftermath of the recent Valeant and Allergan stock price fiascoes, one month ago we showed that when it comes to 2016 hedge fund performance, it has been an abysmal year for the “smartest money” – something even Warren Buffett touched upon during the weekend – primarily due to the residual clustering effect as over the years hundreds of hedge funds ended up being long the same handful of stocks following numerous self-reinforcing “idea dinners” and quasi-collusive attempts to push up stock prices with coordinated buying. While that generated generous returns on the way up, on the way down it turned out into a bloody massacre. The recent plunge in AAPL stock, held by roughly 160 hedge funds as of Dec. 31 (or rather, make that one less after Icahn dumped his shares) only made things worse.
Adding insult to injury has been another widely documented – if ironic – outcome, namely that it has been the stocks which have the lowest hedge fund concentration that have been among the best performers of the year.
This is understandable: by definition the least held stocks are also the most shorted, and since a massive short squeeze has been the chief driver of the market rebound from the February lows, it stands to reason that the most hated names would also be the best performing.
But what is a hedge fund, concerned about FOMO and piling up redemption requests, expected to do in this kind of environment where the general market has once again stormed higher and is returning more than the majority of hedge funds.
As it turns out according to the latest Goldman Sachs data, while the “low hedge fund concentration” stock basket remains the best performing, an unexpected strategy has popped up in the second position: stock that have a “high hedge fund concentration.”
To be sure, in what may be the most glaring bimodal distribution seen in years, the hedge fund world is now so schizophrenic that only the most and least held stocks are notably outperforming the market.
And what may be the biggest surprise, is the following chart showing just how rapidly the “most concentrated” stocks have caught up to the “least concentrated” ones:
What the red shaded area demonstrates is just how furiously hedge funds have scrambled to double down on the most popular stocks within the HF community in hopes of recovering from losses driven mostly by the short book and the outperformance of the low concentration stocks.
Judging by the most recent HSBC reports, while this strategy of further doubling down on the most concentrated names has helped P&L in recent weeks, the reality is that just like China’s recent massive credit injection, it has merely delayed the risk of a disorderly unwind. If and when this latest batch of super concentrated names goes though another period of price distress and forced selling, it will lead to even more acute pain for those hedge funds who no longer have any clue what to do in this “market” but to buy whatever everyone else is buying, and pray.
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