Nobody has "suffered" more under central planning than billionaire hedge fund managers, and as 2016 went on, the suffering continued.
It is no secret to regular readers that over the past decade, hedge funds have not only underperformed the market, but have failed to generate "alpha" since 2011.
As we have shown year after year, the centrally-planned "New Paranormal" has been a total disaster for traditional alpha generation, since with all traditional fundamental relationships flipped upside down thanks to the Fed, the only way to generate outsized returns for one's investors (and one's offshore bank account) is to be massively levered beta, or merely wrong.
Unfortunately for the 2 and 20 crowd, in the second quarter this distressing trend continued, with Goldman's latest Hedge Fund Trend Monitor reporting that in 2016, the hedge fund industry generated a 3% return, underperforming the broader market's 9% YTD return. Worse, the average equity long/short fund and Goldman's own VIP basket have each returned just 2% YTD, both lagging the S&P 500 substantially.
As Goldman's Ben Snider points out, "even with the recent rally in the most popular long positions, the average hedge fund has returned just 3% YTD, lagging the S&P 500 for the eighth year in a row. Many active managers continue to struggle in 2016, with the average large-cap core mutual fund also lagging the S&P 500. Among hedge fund styles, although most have posted similar returns, event-driven funds have fared best (+5%) while equity long/short funds trail (+2%)."
There is some good news: during the last six weeks Goldman's Hedge Fund VIP basket of popular long positions has led the S&P 500 by 470 bp, ending the basket’s record 1500 bp stretch of underperformance since August 2015. However, even with the recent rebound, as the chart below shows, any hedge fund that merely bought the most popular stocks, or otherwise copied what everyone else was doing, is now back to a level last seen in 2008.
Sadly, little of this came from actual stock-picking: as Goldman explains, "VIPs benefitted from a surge in net leverage." After months of declining market exposure, the sharp increase in hedge fund leverage in recent weeks has helped drive VIP outperformance. Goldman Sachs Prime Brokerage reports a surge in net long exposure to 63%, approaching the highest levels in 12 months, from below 50% in 2Q. After declining during 2015 and 1H 2016, leverage bottomed at the end of 2Q, and in subsequent weeks funds boosted market exposure as stocks rallied. In addition to adding leverage through cash equities, call option volume rose to record levels, hedge fund S&P 500 futures exposures climbed by $15 billion, and the share of S&P 500 market cap held short fell to a 1-year low.
To be sure, there was some sector rotation as well, with exposure moving toward cyclical sectors and factors that hedge funds have continued to prefer despite the early 2016 outperformance of bond-like equities such as Utilities and low volatility stocks.
One interesting note comes from a deeper dive into hedge fund holdings, where crowding has declined modestly from recent record highs (as a reminder, BofA recently found that the most preferred stocks by HFs have underperformed the market, while those most neglected have been a consistent source of alpha) but more surprisingly, aggregate portfolio position turnover returned to a record low in 2Q, confirming the ongoing contraction in actual trading, as very few hedge funds rotate in or out of new and existing positions.
Goldman adds that the six-year trend of declining position turnover continued in 2Q, with overall portfolio turnover settling back at its all-time low of 27%. The largest positions, which account for the majority of fund portfolios, experienced just 14% turnover.
In short: hedge funds are stuck trying to disaggregate their holdings from each other, even as they continue to underperform the market in the process while trading increasingly less, instead merely adding even more debt to capture beta and pretend it is alpha.
Finally, for those curious what are the most widely held hedge fund stocks (ostensibly to short them), here are the stocks indicating the largest number of hedge fund investors.
Narrowing down the universe to just the woefully underperforming Goldman hedge fund VIP basket, which consists of stocks in which fundamentally-driven hedge funds have large positions, and consists of stocks that “matter most” as the positions that appear most frequently among the top 10 holdings within hedge fund portfolios, here are the top 50 names.
Finally, for those eager to go long, few lists beat the 50 companies most shorted by the "smart money."
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