Hedge Funds' Near-Record Momentum Bets Keep Coming Up WinnersBy
Equity long-short funds keep bid in market for tech stocks
Highest flyers prove impervious with Apple at two-year high
Managers of active funds have been either incredibly prescient or unusually lucky. Either way, they find themselves heavily concentrated in the strongest part of the U.S. equity market.
With more than half of their bets on high flyers like technology and online retailers, hedge funds have near-record exposure to momentum trades, a strategy that’s up 2.2 percent in August even as the S&P 500 heads for its worst month since the election. The resiliency of the bet was on display Tuesday, when Alphabet and Amazon opened nearly 1 percent lower before rebounding along with Apple to deliver the S&P 500’s biggest intraday reversal in 10 months.
“It’s like these things are like gold -- it’s almost like a safe haven,” said Mark Connors, the global head of risk advisory at Credit Suisse Group AG. “This resilient price action in equities is commensurate with the constructive positioning we see across hedge fund strategies and speaks to the persistent positive sentiment in 2017.”
How long it can last is a question that’s becoming more urgent for hedge funds that have finally caught up to a market where gains are delivered by an ever-narrowing cohort of stocks. Volatility has been rising amid renewed geopolitical tensions, signs of uneven economic growth in the U.S. and the threat of further interest-rate hikes by the Federal Reserve.
What’s more, the very nature of following momentum poses its own pitfalls. The strategy is one of the more volatile factors, and when rotations occur, pain seeps through as leaders quickly move to the back of the pack.
All that points to a hedge fund love affair that’s headed for heartbreak, according to Joseph Mezrich, head of U.S. quantitative analysis at Nomura Instinet LLC.
“We are concerned about this outsized exposure,” Mezrich, wrote in a note to clients. “The last time momentum exposure was this high was in 2013-2014, which led to a sharp decline in fund performance when momentum collapsed. Fund managers may be setting themselves up for a repeat.”
Managers that follow the strategy found themselves corralled into technology, as the group’s proxy for growth expectations and outsize profits pushed shares higher. Though it helped managers beat benchmarks, the potential for momentum to collapse threatens to end the recovery in active management, said Mezrich.
Among hedge funds’ top 100 long positions, 45 percent are information technology stocks, data from Credit Suisse show. That compares to the S&P 500 where tech holds a 23 percent weighting.
Connors said managers learned a key lesson during a beat down from a momentum shift in early 2016 -- while bets on tech might be concentrated, this time they aren’t levered. Without leverage, the bet is less fragile. It means the market leadership can march on, unperturbed for a while, said Connors.
Tuesday’s short-lived declines sparked by North Korea’s latest missile launch proved that it’s going to take a lot to shake the hedge fund favorites, he said. As such, managers have been validated by holding on to what works.
“You can’t manage your book for a big deleveraging,” said Connors. “Momentum is an escalator up and an elevator shaft on the way down. But managing that is what active managers do for a living.”