Here’s What Worked for Hedge Funds in 2015
While 2015 was challenging for hedge fund managers, many of them have proven their ability to discover alpha in a complex market environment.
While there is little doubt that 2015 was a challenging year for many hedge funds, there were a few bright spots where managers were able to capture value and add alpha. In short, what worked in 2015 were stocks in the mega-cap space that were responsible for the majority of the growth in the US Equities market for the year. While they were not obscure names, hedge funds were successful in not only identifying these stocks but also allocating to them heavily. Given the poor market breadth we’ve seen, this was an important source of alpha for managers struggling to find value elsewhere in the markets. For this post we’ll use public ownership data and the value-weighted portfolio of hedge funds we call the Hedge Fund Universe (HFU).
Let’s briefly review the opportunity set for a fundamentally driven or event driven hedge fund manager operating in the US equities space. The S&P 1500 index is off slightly YTD 2015 as of yesterday, with the winners contributing 8.36 percentage points (836bps) and detractors costing the index 849 bps. Out of the positive contribution, 230bps or 27% is attributable to just five companies and 36% to just ten. In other words, over one third of positive P&L of the 1500-company index came from ten stocks and 90% of the gains came from 10% of the stocks. Furthermore, 60% of stocks in the index had negative returns on the year, and the only reason the index is basically flat is that positive performance was skewed towards larger companies, and the index is market-cap weighted. This makes for a tough stock picking environment for any active manager. While managers are generally underweight mega-caps and overweight mid-caps, they were able to identify the right mega caps to hold.
Average returns of stocks in the S&P 1500 by Market Capitalization bucket: 2015
Hedge Fund attribution by market cap bucket (Security Selection and Market Cap effect)
The Trade Managers Got Right: FANG
Managers were, and still are, heavily long FANG, the group of four stocks that are responsible for one fifth of the markets gains this year. Facebook, Amazon, Netflix, and Google (Alphabet) are to hedge funds this year what the healthcare sector was last year – a God-send.
The top contributor was Amazon (AMZN), as the internet retail giant more than doubled during the year. In all, 150 hedge funds got this right, and (on average) sized up the trade each quarter of this year. Tiger Global made a huge conviction bet on the name in the third quarter of the year, their recent filings showing a 20% position. Viking Global, Lone Pine, Point72, Coatue, and Discovery were among the funds that participated in the windfall.
Amazon: Price vs. quantity held by hedge funds in 2015
A few years ago, many fundamental investors were short Netflix, betting that mail-ordering DVDs was a terrible idea. After a pivot to online streaming, Netflix is now a massive long, and it has certainly been rewarding for those that participated. The stock rallied 140% in 2015 to the benefit of 116 hedge funds mangers with Tiger Global leading the pack. Other managers that recognized and capitalized on the opportunity were SRS, Coatue, Viking Global, EMS Capital, and Criterion.
Google and Facebook were number two and number five top contributors, respectively. Similarly, hundreds of managers recognized the value early and benefited from the rallies.
Top HF Position by Value: Allergan (AGN)
Second only to Apple in popularity, Allergan is a favorite among hedge funds. It’s held by 170 managers in our universe of about 1,200, and is a top position in terms of total dollars invested by hedge funds. In a merger that created the world’s largest drug maker, Pfizer acquired Allergan, the maker of Botox for $160B in November of this year, and the stock is up 20% YTD. Take a look at how hedge funds built their position, as they more than doubled the quantity of shares held leading up to the merger:
Hedge Funds build position in Allergan in 2014 – 2015
Viking Global called this one right again, making it their top position (as of 9/30 filings with pricing pulled forward). Others that invested heavily in the name were Paulson, Third Point, Pentwater, and Och-Ziff.
While the environment continues to be challenging for hedge fund managers, many of them have proven their ability to discover alpha in a complex market environment. Most of the top contributing trades we covered today are household names, widely covered by analysts and media. Yet, managers recognized that the market was under-valuing those names and capitalized on a nice bounce in 2015. Unfortunately, the same cannot be said of the less liquid and underfollowed names that hedge funds participated in this year. In 2015, crowding hurt while liquid mega-cap names offered the most profitable opportunity. Next year we’ll be sure to follow every significant trade hedge funds make to see if there’s a characteristic bounce in the less liquid and smaller market cap names held by hedge funds.
The Hedge Fund Survival Guide: Volume One
While the reasons may be disputed, most will agree that the past few years have presented enormous challenges to hedge fund managers and active managers in general. As evidence, we’re beginning to see higher-than-normal closures and redemption suspensions from previously successful managers. It feels like it’s more than just a string of bad bets. It feels like the current market regime isn’t conducive to the fundamental research and value investing that has served managers for decades.
Incredibly, we’ve seen some of the most celebrated, marquee hedge funds struggling in situations like Valeant, Community Health, and Sun Edison. In this environment, it’s no longer enough to be a great stock picker. Managers need to evolve.
This is why we’ve begun publishing exclusively for the hedge fund manager, The Hedge Fund Survival Guide.
This practical guide outlines the best-in-class practices of the top hedge funds in concepts such as risk management, analyst compensation, client reporting, and attribution analysis. It’s a must read for hedge fund managers that are committed to improving—instead of fading away in this new market regime.
Download our latest research to learn more.