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Industry Analysis

State of the Industry: October 2019

October was a strong month for markets and hedge funds. AAPL scored a second month at the top of the chart for security alpha generation.

Nathan Innis
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Q4 is off to a strong start, with hedge funds returning 2.21% in October, outpacing the S&P by 0.05% (2.16% for the month), and the MSCI World by 0.24% (1.97% for the month).

The Russell 2000, Russell Growth, and Russel Value all had great months as well, clustered within the 2.40% - 2.80% range. Euro Stoxx 50 was the laggard at 1.41%, while Asian stocks soared, as indicated by the Nikkei 225’s 5.35% return for October.

Hedge funds outperformed the market in eight out of eleven sectors in October. As the Novus Framework shows below, Health Care is the sector where hedge fund managers have shown the strongest security selection skill this year. Two of the top performing hedge funds in October actually focus on Health Care names (Cormorant & Tang), according to public filings.

On the other hand, Communication Services and IT names have returned very well this year (25.06% and 36.13% respectively), yet hedge funds have so far failed to demonstrate an ability to pick the outsized performers (in aggregate) compared to sector benchmarks in either sector.

Hedge Fund Universe: YTD Performance Attribution, by Sector. Security selection has detracted 27 bps from IT and 29 bps from Communication Services, and added 41 bps of alpha to Health Care.

Once again, our Top 5 managers scoreboard is dominated by smaller funds, with the exception of Cormorant, whose long market value is reported to be 1.68 bn. At the time of writing, Tang Capital’s simulated performance suggests an astounding 44.20% YTD as of October 31, thanks to Odonate Therapeutics, which accounts for almost two-thirds of their reported holdings.

Things are back to normal for our hedge fund indices this month, after all four Novus 4Cs posted negative returns in September. Consensus led the pack by returning 4.59% in October, bringing YTD performance to 22.64%. Not quite enough to displace our favored Conviction Index, which boasts 25.50% YTD.

AAPL was the largest outperforming name for hedge funds for the second month in a row. Despite dull growth figures for iPhone sales, investors are responding favorably to the company entering into new markets like credit cards, online gaming, and video streaming. Year to date, the company’s stock has risen 65%, lifting the valuation to $1.114 trillion. As Barrons points out, “That is like taking the [Apple] valuation as of the end of 2018, and tacking on the current value of International Business Machines (IBM), plus SAP (SAP), plus Salesforce.com (CRM), and having room to spare.”

Market signals are still mixed—we saw strong earnings reports from some, while uncertainty with China remains, and low GDP growth numbers tempt the Fed to cut rates again. Some experts say market volatility is overdue. Mixed signals, however, also mean opportunities exist for those who are able to show they can identify true value admidst the noise.

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