These Small Cap Energy Stocks That Hedge Funds Love Have Been Getting Crushed

Updated on

Losses are again ballooning in a corner of the U.S. stock market where professional speculators roam.

Small-cap shares tracked by the Russell 2000 Energy Index have plunged 34 percent in three months, including a 24 percent skid since June 26 in which the group posted four straight weekly losses averaging 6 percent each. Rex Energy Corp. and Penn Virginia Corp. fell more than 50 percent in July alone.

Bottom fishing was rife in the Russell gauge after it plunged 52 percent in the six months ended Jan. 15, driven down by the drop in oil prices. Hedge fund ownership among the 93 companies in the gauge is roughly twice what it is in the rest of the American stock market, data compiled by Bloomberg show.

“Energy tourists like macro funds, technicians and general equity funds that aren’t commodity specialists are now getting hammered,” Benjamin Dunn, president of Alpha Theory Advisors, which advises hedge funds with about $6 billion in assets, said from Crested Butte, Colorado. “There’s no reason to be long in these names based on the fundamentals.”

While little has been spared in the selloff -- oil, junk bonds and even Chinese equities have been hit -- smaller stocks have been the worst off. Even with a 17 percent retreat in the S&P 500 Energy Index, selling has been bad enough in the Russell gauge to send it to its lowest point versus large caps in 15 years.

The Russell 2000 Energy Index fell less than 0.1 percent at 9:42 a.m. in New York, while energy companies in the S&P 500 added 0.5 percent.

‘Buy Everything’

Who’s getting hurt? Anyone who couldn’t resist taking a flier on the group in April, says Dunn. Back then, traders were looking to snap up energy shares and the only requirement was a depressed valuation.

“There were retail brokers dialing me up saying oil is down 50 percent and looking to buy everything,” Dunn said. “They weren’t really differentiating by balance sheet or fundamentals. If it was energy-levered equities, they wanted it.”

Oil failed to hold its rebound and that approach backfired. After recovering 41 percent from a low in March to a six-month high in June, crude gave way to another 23 percent selloff over seven weeks.

U.S. output has held near a four-decade high while the largest OPEC members pump at record rates, keeping the market oversupplied. As a result, long positions in oil taken by hedge funds and other large market speculators dropped to a two-year low last week while short holdings climbed 25 percent, U.S. Commodity Futures Trading Commission data showed last week.

Short Interest

For bears the selloff has been profitable. Energy companies in the Russell 2000 were the most heavily shorted in the index at the end of June, according to data compiled by Bloomberg.

Short interest, the amount of uncovered short positions held by investors, represented 10 percent of the average energy company’s outstanding shares, data provided by Markit show. That compares with an average 4.5 percent in the overall index.

The PowerShares S&P SmallCap Energy Portfolio saw its market capitalization shrink 38 percent since the most recent selloff starting April 15. The fund now has a market value of $34 million.

“When big entities are in small stocks, they have to react quickly,” John Manley, who helps oversee about $233 billion as chief equity strategist for Wells Fargo Funds Management in New York, said by phone. “That’s exacerbating the selling situation. It would’ve happened at some point, but the hedge funds make it happen faster and make it seem more painful.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE