ETFs That Copy Hedge Funds Bear the Brunt of a Crowded Selloff

Hedge Fund-Replicating ETFs Hurt By Summer Selloff
  • ETF tracking top hedge fund stocks has lagged S&P 500 in 2015
  • Large fund managers pared equity exposure in third quarter

Exchange-traded funds designed to mimic the strategies of hedge funds are mimicking their way into some serious losses of late.

Since the start of August, the Global X Guru Index ETF, which is tied to hedge funds’ top holdings using 13F filings, has slipped 9.5 percent, a casualty of popular trades that fell during this summer’s selloff and have so far failed to get back up. The Standard & Poor’s 500 Index has declined just 0.7 percent over the same period and recovered all of its 11 percent August correction.

“When something like this is opened up to retail investors, they tend to get the worst out of the deal,” said Bill Schultz, who oversees $1.2 billion as chief investment officer at McQueen, Ball & Associates Inc. in Bethlehem, Pennsylvania. “It’s not something that we find particularly attractive for our clients.”

The AlphaClone Alternative Alpha ETF, which tracks the performance of U.S. equities to which hedge funds and institutional investors have disclosed “significant” exposure, has lost 18 percent since the start of August.

The S&P 500 increased 0.1 percent to 2,089.14 at 4 p.m. in New York.

While lining up with the biggest speculators can make sense when markets rise, it has the potential to increase the pain on the way back down as everyone bails from losing bets at the same time. Trepidation has been in no short supply among money managers, with funds run by Stan Druckenmiller, Louis Bacon and David Tepper among those that disclosed declines in U.S.-listed equity holdings in the third quarter.

Quick selloffs are even more pronounced for stocks with “crowded” hedge fund positioning, according to Stan Altshuller, chief research officer at Novus Partners Inc. Novus measures crowdedness not only by the percentage ownership by hedge funds, but also by how many different firms are invested at the same time and how easy it would be for them to liquidate, he said.

Using this approach, a basket of the 20 most crowded stocks has trailed the S&P 500 by 21 percent from the start of June through Nov. 4, Novus data show. Companies such as Community Health Systems Inc., which decreased as much as 59 percent over the period, and Ally Financial Inc. are to blame for the underperformance.

“Nobody seems to grasp the severity of crowding as a risk,” Altshuller said by phone. “When the opportunity to exit is narrow, and there are a lot of funds in the stock, that creates the most dangerous type of situation. These stocks get absolutely crushed in times like these.”

Aligning one’s holdings with those of hedge funds hasn’t always been a losing proposition. A Goldman Sachs Group Inc. gauge that identifies the most popular bets across firms had annual returns exceeding the S&P 500 in each year from 2012 through 2014. That’s changed in 2015, with the Hedge Fund Very Important Positions Index trailing the benchmark index by 5 percentage points year-to-date, Goldman Sachs data show.

While hedge funds are the ones making headlines when stocks quickly go south, retail investors are often the ones left holding the bag, says Tom Wirth of Chemung Canal Trust Co.

“If a large percentage of hedge funds own a specific stock and the news turns, they’re more likely to get out of a position very quickly, while individual investors tend to not act so quickly,” said Wirth, senior investment officer for Chemung Canal Trust, which manages $1.9 billion in Elmira, New York. “Selling can be exacerbated. Volatility can be exaggerated.”

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