Goldman’s Kostin Sees Hedge Funds Playing in Shrinking Sand Box

Here’s the problem facing hedge funds investing in the stock market this year, according to Goldman Sachs Group Inc. chief equity strategist David Kostin: the sand box they like to play in has gotten a lot smaller.

For example, equity hedge fund managers tend to have about a quarter of their investments in consumer-discretionary stocks, Kostin told Erik Schatzker and Stephanie Ruhle on Bloomberg Television’s “Market Makers” program today. The dispersion of returns within that group is too small for managers on the prowl for stocks to buy or short, Kostin said.

“The opportunity set, the sand box, the swimming pool is very, very small,” Kostin said. “It’s been a very difficult year from a stock-selection perspective.”

The biggest gain among consumer-discretionary stocks over the past three months has been a 10 percent advance in Nordstrom Inc. and the biggest loss has been a 17 percent drop in International Game Technology. That 27 percentage point dispersion of returns compares with a 71 percentage point difference during the same period last year, according to data compiled by Bloomberg.

Goldman Sachs’ basket of the 50 stocks favored by hedge funds has underperformed the Standard & Poor’s 500 Index by about 2 percentage points so far this year after beating the market for 13 straight years, according to Kostin.

‘Glamor Stocks’

Some of the more richly valued “glamor stocks” have dropped down or off the list of hedge-fund ownership, according to Kostin, as managers become more value-oriented.

Verizon Communications Inc., Walgreen Co., American Realty Capital Properties Inc., CF Industries Holdings Inc., Forest Laboratories Inc., Halliburton Co., Cheniere Energy Inc., News Corp. and SunEdison Inc. were added to the firm’s Hedge Fund VIP Basket, according to a May 21 report. Express Scripts Holding Co., Gilead Sciences Inc., Visa Inc., Cole Real Estate Investment Inc., Liberty Global Plc, MasterCard Inc., Ocwen Financial Corp., T-Mobile US Inc. and Vodafone Group Plc were dropped.

Kostin said, as a whole, he believes the market is fairly valued currently as the S&P 500 trades about 11 points above his year-end forecast. The median stock in the S&P 500 sells for about 17 times estimated earnings over the next 12 months, according to data compiled by Bloomberg.

While “that’s expensive on a historical basis,” Kostin said growing profits will keep equities rising “modestly toward the upside.” The strategist expects the S&P 500 to reach 2,100 by the end of next year and 2,200 by the end of 2016.

This should give everyone plenty to talk about if they run into Bill Ackman or David Einhorn in the sand box.

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