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Industry Analysis

FB, FLT, MSFT & More: Technology Conviction at 5-Year High

In this article, we'll examine some of hedge funds' biggest conviction securities in information technology and see how they've performed.

Brett Turenchalk
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The September launch of the iPhone 7 drew large crowds to Apple stores around the world. Here in New York, over a hundred people descended on Apple’s iconic store on the east side of Grand Central (and below Novus’ office). In similar fashion, hedge funds have swarmed Apple and similar high-profile Technology companies, such as in last year’s FANG trade. HFs have shown conviction in Tech companies for their enticing growth stories and overall sector advantages, such as high dispersion. We can clearly see this Tech focus and other hedge fund positioning using Novus’ ‘Four C’ Indices.

Public Data

The positions underlying each index are sourced from an aggregate portfolio of hedge fund filings called the Novus Hedge Fund Universe (HFU). The HFU is composed of over 1,300 vetted, public hedge fund portfolios. Everything mentioned in this post is sourced exclusively from public data. The data used here omits the short side, non-equity securities, many non-U.S. securities, and all non-public securities. To simulate performance and determine portfolio attributes, such as liquidity, we combine public holdings data with market and pricing data.

Novus Conviction Index

Out of Novus’ Four Cs, our Conviction Index generates the highest annualized return, outperforming the others by a wide margin. It matched both the Concentration Index’s performance and Consensus’s low volatility during the recovery period—while avoiding the former’s cliff-dive in 2015.

conviction in technology

This index is comprised of twenty stocks in which the highest number of managers have invested a significant portion of their portfolio. Conviction is an expression of both security selection and position sizing.

Between mid-2015 and 2016 Q3, the Conviction Index had an unprecedented surge in information Technology exposure, rising from 20% to 56%. This Tech/Discretionary focus closely resembles the typical Tiger Cub hedge fund.

conviction in technology

Relative to the S&P 1500, the Conviction Index is 35% overweight Tech.

conviction in technology

These are the 6/30 Tech positions within the Conviction Index:

conviction in technology

FleetCor became a conviction position in the first quarter of 2016, and PayPal and CommScope were added in Q2. The rest of these names have been in and out of the portfolio for multiple years.

This Tech overweight pushed the portfolio’s value multiples to new highs. Historically, the Conviction Index closely tracked the S&P 1500’s TTM median P/E, though over the last year, it rose above this range and has now passed one absolute deviation from the median.

conviction in technology

It also recently surpassed the S&P 1500 Information Technology Index’s median TTM P/E.

conviction in technology

We see a similar rising trend when looking at the Conviction Index’s other multiples, like median TTM EV/EBITDA and P/S:

conviction in technology

These higher value multiples support the observed trend in the index’s value beta, which turned negative as Conviction’s median P/E increased.

conviction in technology

Security Selection & Liquidity

There are two reasons that hedge funds might be comfortable with these higher multiples.

Firstly, the Tech and Discretionary conviction picks generated sizeable security selection alpha (outperformance above their sector benchmarks) over the last five years.

conviction in technology

These sector overweights continue to be accretive in 2016:

conviction in technology

Secondly, a large majority of securities in the portfolio are very liquid, with trailing ninety-day average daily volume greater than $100 million.

conviction in technology

Key Takeaways

Hedge funds currently exhibit high conviction in Tech and Consumer Discretionary stocks and appear comfortable with elevated value multiples. This is likely due to the successful track record of security selection in these sectors and/or the healthy liquidity profiles of stock names.

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