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Hedge Fund Trends, Institutional Investing

Q4 2016 Hedge Fund Trends for Institutional Investors

Stan Altshuller Chief Research Officer

In this piece, fresh off the release of Q4 2016 HF ownership data, we dive into the latest hedge fund trends for institutional investors.

As usual, following the SEC’s release of quarterly holdings data, we’ve crunched the numbers and collected the top four hedge fund trends for Q4 2016. For those new to this blog, the data used here comes strictly from public sources. We’ve compiled a proprietary aggregate portfolio called the hedge fund universe (HFU) that’s based on public disclosures from ~1,300 hedge fund managers and weighted on reported market value. Let’s take a look.

Hedge Fund Crowdedness is at an All-Time High

Crowdedness vs. HF Long market value: hedge fund trends q4 2016

While market value (solid line) and crowdedness (dotted) moved in lockstep over the last decade, this past year the two metrics decoupled. Crowding has increased more than market value. (Learn how we measure crowding here). This implies that managers are investing in more of the same securities. Thus, investors, it’s more important than ever to measure the manager overlap in your portfolios. In many cases, managers aren’t aware how crowded their own investments are, and are even less aware of how much diversification they bring to your lineup.

Liquidity Declines Further

hedge fund trends q4 2016

Another side to crowding, besides the volume of managers invested in the same securities, is liquidity in those securities. We assess liquidity for the whole HFU as the portion of the long holdings that can be liquidated in thirty consecutive trading days. The solid line above represents this metric over the last decade. Not surprisingly, it moves with negative correlation to the market value controlled by managers (dotted line). Dollars controlled by hedge funds are near all-time highs, and liquidity is at near-record lows, indicating that only 16% of market value can be liquidated in thirty days, down from 19% last quarter.

Recently, Bloomberg found evidence of our liquidity metric linked to overall market performance. While this is interesting at first glance, more work must be done to confirm this relationship.

Managers Move Up the Market Cap Spectrum, but Not as Much as the General Markets

hedge fund trends q4 2016

hedge fund trends q4 2016

This is a trend we’ve seen developing for a while, but it’s important enough to bring up again. The first graph shows the weighted average market capitalization for HFU (solid line) against that of the market (dotted). On average, hedge fund managers are still well below the market in terms of capitalization value of the companies in their portfolios, despite consistently moving up. More recently, as that metric shifted meaningfully for the markets, managers resisted most of the uptick, increasing only moderately.

The four smaller charts are HFU’s capitalization weights relative to the S&P 1500. The source of this recent divergence can be traced to an underweight trend in mega and overweight trend in small-capitalization securities. Managers continued to rotate out of small caps, however, as that bucket’s overweight became less significant throughout the quarter.

This corroborates our findings that generating alpha in smaller capitalization securities has been difficult as of late.

Alpha Drivers Came from Energy and Health Care, not Financials

Contrary to common belief, most of the alpha generated by hedge funds from last quarter until now has not come from Financials. In fact, this sector cost hedge funds a bit of alpha, even as it was the top contributor in terms of total P&L. Hedge funds have likely been moving into Financials as a response to the perceived impact that deregulation will have on the sector.

hedge fund trends q4 2016

Technology, the second highest absolute contributor, was the greatest source of negative alpha, stemming mainly from FB and GOOGL.

For more trends and factors for 2017, take a look at our State of the Industry Report, updated monthly with data from our proprietary Hedge Fund Universe.

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