Hedge fund herding is worse than ever

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The US stock market’s “Magnificent Seven” have been a headache for mutual fund managers, who have mostly eschewed them and are paying the performance price.

Hedge funds have taken a different tack — in short, they yelled “YOLO” and jumped in with both feet. From Goldman Sachs this morning (their emphasis):

The combination of elevated hedge fund concentration and the strong performance of popular stocks has supported returns this year but lifted our crowding index to a record high. Our Hedge Fund VIP list of the most popular long positions has returned +31% YTD, and most of the “Magnificent 7” mega-cap tech stocks remain at the top of the list. Mirroring the increasing concentration in the equity market, concentration in hedge fund portfolios has risen; the typical hedge fund holds 70% of its long portfolio in its top 10 positions. These dynamics have also lifted hedge fund exposure to the Momentum factor to a near record.

Hedge fund crowding is now the most extreme it has been in the 22 years that Goldman has tracked hedge fund positioning, narrowly pipping the previous high from 2016.

Or, on a chart:

This is from Goldman’s quarterly Hedge Fund Trend Monitor, which analyses over 700 hedge funds with $2.4tn of gross stock positions. The study is based on 13-F filings and supplemented with data from GS’s prime brokerage desk.

As Alphaville has previously written, hedge funds have been chasing/pumping up the AI craze all year, but the latest instalment of the GS report indicates that this trend has reached a new degree of frenzy.

Hedge funds lifted their exposure to the Magnificent Seven — Microsoft, Alphabet, Apple, Nvidia, Tesla, Amazon and Meta — to a new record in the third quarter. They now account for 13 per cent of the aggregate hedge fund long portfolio, twice their weight at the start of 2023.

This is admittedly only roughly half these stocks’ weight in the Russell 3000, but it looks like this has likely been a major contributor to their outsized rally this year. By FTAV’s calculations, that’s now a $208bn bet on the Magnificent Seven.

According to Goldman’s prime brokerage desk, hedge fund net exposures in these stocks currently rank in the 99th percentile since 2016, compared with just a 12th percentile position at the start of 2023.

Aside from Tesla, each of the seven rank among the top 10 members of Goldman’s so-called “Hedge Fund VIP” list of the most popular bets. Microsoft and Amazon have been the top two VIPs for nine consecutive quarters.

Here’s the full current VIP list (zoomable version):

This has obviously helped performance in 2023, but it increasingly looks like an accident waiting to happen.

Hedge fund exposure to momentum has rarely been as extreme as this, and the swing since 2022 has been astonishing.

Momentum can be fun to ride, but it has a nasty tendency to suffer sudden crashes. Given how large some of the big tech stocks are in hedge fund portfolios — and how strongly they’ve rallied this year, at least partly as a result of the outsized hedge fund buying — any reversal could become violent.

On an aggregate level, hedge funds are still pretty cautious though. Gross exposure has hit a new record, but their net market exposure remains modest because of short positions.

However, these days most of the shorts are bets against the index through ETFs and futures, not individual stocks.

Once again, there’s a lot riding on Nvidia’s results later today . . . 

Read the author’s full story here

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