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Hedge funds are nonetheless licking their wounds after a retail buying and selling frenzy pressured the business to slash its total publicity to shares, resulting in an underperformance in 2021.
Final month, a military of retail buyers who coordinated on social media managed to push GameStop shares up 400% in only one week, creating large squeezes in a slew of closely shorted names. Hedge funds getting burned on their brief positions scrambled to take down total danger and promote winners to lift money.
This kicked off a domino impact that led to hedge funds’ largest week of de-leveraging since February 2009, in line with knowledge from Goldman Sachs’ prime brokerage unit.
The mud has but to settle because the injury inflicted by the so-called dumb cash appears to be lasting. The 20 hottest lengthy positions amongst hedge funds have lagged the S&P 500 by greater than 1% yr so far on common, in line with RBC’s evaluation of 330 hedge funds primarily based on the current regulatory filings.
“It’s partly as a consequence of hedge fund degrossing in January as hedge funds reacted to the retail buying and selling frenzy that gripped fairness markets,” Lori Calvasina, head of U.S. fairness technique at RBC, mentioned in a be aware. “The influence from January hedge fund degrossing has greater than offset the restoration in efficiency seen from late January by way of mid February.”
In the meantime, newbie retail merchants, typically scolded for his or her lack of sophistication in comparison with Wall Avenue professionals, are constructing on their momentum even after a lot of the brief squeezes are accomplished.
A basket of retail favourite shares has rallied 18% this yr, outperforming a basket of the preferred hedge fund lengthy positions by eight proportion factors and the S&P 500 by 4 proportion factors, in line with Goldman.
This David versus Goliath battle got here at a very susceptible time for hedge funds. Skilled merchants had already gotten caught in a giant market rotation out of their tech darlings and into cyclical names amid an financial restoration. Progress-loving hedge funds are nonetheless underweight power and financials, two of the most important winners this yr with a rally of 25% and 10%, respectively.
The GameStop mania additionally highlighted the hedge fund neighborhood’s Achilles’ heel — a excessive degree of leverage and focus. Hedge funds entered the brand new yr with the very best ranges of web and gross publicity on file, in line with Goldman.
“The January brief squeeze illustrated how the mixture of leverage and crowding creates danger each for hedge fund returns and broad market efficiency,” David Kostin, Goldman’s head of U.S. fairness technique, mentioned in a be aware.
Hedge funds’ portfolio focus and the diploma of crowding additionally remained elevated traditionally, Goldman’s knowledge confirmed. The highest 5 most owned shares by hedge funds — Amazon, Microsoft, Facebook, Alphabet and Alibaba — have remained the identical for 10 consecutive quarters, Goldman mentioned.
Nonetheless, not all hedge funds emerged battered from the brief squeeze saga and those that dodged the bullet are usually extra cautious about taking up danger.
Third Level’s Dan Loeb, whose hedge fund sidestepped steep losses caused by the GameStop mania, mentioned in a Feb. 10 letter to buyers that he all the time felt extra snug with greater web and decrease gross publicity, that means his fund tends to have greater lengthy positions than brief.
Loeb additionally mentioned he realized his lesson betting in opposition to names with outsized brief curiosity.
“After just a few earlier painful experiences of our personal taking positions in opposition to firms with massive brief pursuits, we had a preview of what can occur and minimize our losses,” he mentioned within the letter.
— CNBC’s Michael Bloom contributed reporting.
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