How COVID-19 is Impacting Popular Hedge Fund Stocks
As market volatility persists, investors have a lot of questions. Today, we can at least provide one answer: how popular hedge funds stocks have fared.
Updated March 24, 2020.
Coronavirus continues to take its toll on the health and wealth of our global community. We can begin to understand the impact of COVID-19 on hedge funds by looking at the Novus 4Cs, a collection of indices that Novus creates by aggregating data across the Hedge Fund Universe. We produce four different indices by compiling public filing information and filtering top 20 stocks based on quantitative criteria. Each is designed to examine the holdings and performance of hedge funds through a different lens:
- Conviction: Managers express conviction in companies by the size of their positions. This index looks at the stocks which commonly represent a certain (proprietary) percentage of total reported exposure within individual manager portfolios.
- Consensus: Comprised of the stocks most commonly held by hedge funds, regardless of position size. This index is simply the most common names across hedge fund portfolios.
- Concentration: This index tracks stocks with the highest percentage of total shares outstanding held by hedge funds. We set quantitative thresholds when constructing this index to avoid penny stocks, closely held stocks, or extremely illiquid stocks with few holders.
- Crowdedness: Crowdedness scores are assigned to each security within the Hedge Fund Universe based on a two-factor weighting system: number of total owners, and percentage of ADV owned by hedge funds in total.
Our primary method for evaluation is the Novus Framework, which seeks to decompose position-level performance into Market, Sector, and Security components. This “opportunity cost” analysis tells us how much contribution (or in some cases detraction) can be attributed to broad market movements, to the movements of each position’s relevant sector, and finally to the individual stock’s over- or under- performance.
Findings: Conviction is (still) King
The Conviction Index continued to outperform this week, as we've come to expect. Defined as the 20 names that most frequently appear over a certain position size threshold, this index has historically been the strongest of the 4Cs. Here is some background on the index vs the S&P 1500, as well as the MSCI World from Dec 2010 through the end of 2019.
Now let's zoom in on Conviction performance YTD.
Showing conviction in a name seems to be a good predictor of outperformance, historically speaking. Year-to-date outperformance of the Conviction Index in the Coronavirus era can be attributed to two things: sector allocation and security selection. The index is primarily exposed to sectors that were relatively less hard hit by market swings, such as Information Technology and Communication Services. Almost 70% of total exposure in the Conviction index falls into these two categories. Low exposure to Financials and zero exposure to Energy has also preserved value.
Breaking down performance with the Novus Framework allows us to dive deeper into the individual securities, how they performed relative to the market, and if they were able to outperform their relative sector. In this case, the S&P 1500 Composite TR serves as the broad market benchmark, and the underlying S&P 1500 GICS level sector benchmarks are used for targeted sector analysis. Here is the contribution breakdown in bps through March 20th:
This tells us that the Conviction Index lost about one third less than the broad market, all things equal (-2,271 bps vs -3,360 bps). As we would expect, given our review of sector exposure, we see positive sector contribution (473 bps) due to high conviction names tending to fall into sectors that dropped less than other areas of the market. More importantly though, we see most of the insulation effect (595 bps) coming from Security Selection, or outperformance of the stocks relative to the market and their peers.
The majority of this Security Selection is coming from Communication Services and Information Technology stocks, showing that even within insulating sectors hedge funds are able to select names that tend to resist downward forces more than their industry peers.
In 2016, Novus and Barclays entered a partnership to develop an index to systematically track commonly held stocks from within the hedge fund universe, based on these public regulatory filings. The outcome of this partnership was the Novus Barclays Public Ownership Indices, with Novus acting as the data / algorithm specialist to develop data indices, and Barclays Investment Bank separately providing an investible vehicle.
For inquiries about the index product, please contact Barclays Investment Bank at NovusIndex@barclays.com.
The Other C's
Not all the 4Cs paint the same rosy picture of hedge fund stock-picking ability. The least impressive is the Concentration Index, defined as the 20 stocks with the highest percentage of shares outstanding held by hedge funds in aggregate. As you can imagine, this high-octane collection of stocks tends to be volatile, frequently suffering from sharp drawdowns. In general, it appears these periods of underperformance are due to lack of liquidity and crowd-selling behavior. Here is how this high-concentration index performed YTD during Coronavirus volatility.
As you can see, rather than preserving value relative to the broad market’s decline, it managed to drop 70% more in the same period.
We'll continue to provide updates as the days progress. Stay safe and well.