Hedge funds are piling into the same shares that zapped their returns at the start of the year.
They just added momentum stocks for a fifth consecutive quarter, according to an Evercore ISI analysis of 13F filings with the Securities and Exchange Commission. Those shares, loosely defined as the ones that went up the fastest in the past 12 months, posted some of their worst losses in seven years at the start of 2016.
Rather than shying away, managers snapped up popular shares that had been punished. Large technology and consumer discretionary companies like Netflix Inc. and Amazon.com, beaten down in their worst quarters since 2014, remained among the most widely held. Plunging prices weren’t a deterrent — rather they drew in investors who believed that the pummeling was too severe.
“Hedge funds are not benchmarked. If they want to continue to play momentum and maybe had got beaten down, they could still add to technology names that were sold off in February,” said Benjamin Dunn, president of Alpha Theory Advisors, which works with hedge funds overseeing about $6 billion. “They may have added to names that were in the momentum indexes at the lows, thinking that the move is overdone based on technicals and not fundamentals.”
The investment approach rewarded its followers with record gains in 2015, only to break down this year.
A momentum portfolio drawn from about 2,000 stocks posted a negative return of 4.5 percent in the first four months of 2016, the biggest loss since August 2009, according to the Bloomberg U.S. equity model. The so-called pure-factor portfolio was long stocks with high price momentum and short those with low, while neutral to all other factors.
Even though the trade remains popular, hedge funds don’t necessarily own the same stocks they did in 2015. Shares move in an out of the momentum category depending on their price change over a specified period. Among the biggest changes since January: the weighting of health-care companies increased by four percentage points in an Evercore ISI long-momentum basket of 50 companies. Baxalta Inc., a newly anointed health-care momentum name, also leaped into the top 15 large-cap hedge fund overweight positions.
“They’re not necessarily going long the same stuff or shorting the same stuff, so it’s not that unusual to see them add to this price momentum factor,”said Abhra Banerji, the director of quantitative research at Evercore ISI. “Definitely crowdedness is a concern here, but it can still work out. It just depends on the timing of it. ”
Consumer discretionary and technology shares nevertheless retained their large presence in the momentum basket. Likewise, managers added the most to those two industries in the first quarter, with the biggest positions in Google’s parent Alphabet Inc. and Time Warner Cable Inc. The most discarded industry was financials, which saw its position in the momentum basket fall by four percentage points.
At the same time, hedge funds have taken an increasingly bearish view on stocks priced at deep discounts to things like earnings and assets. Managers are now positioned away from the value trade to the greatest extent in at least six years.
So far this month, hedge fund bets on the two factors have paid off. From the start of May though Wednesday, value sank 0.7 percent, while momentum posted a 1.5 percent gain, according to the Bloomberg U.S. equity model. But the trade may not continue to succeed for much longer, according to JPMorgan’s Dubravko Lakos-Bujas.
“We stay short momentum since it remains expensive relative to history and to the market (despite its year-to-date selloff), has become increasingly crowded and is dependent on further strengthening in USD,” wrote the chief U.S. equity strategist in a note to clients Thursday. “By contrast, we favor value which is cheap on a relative basis and offers better risk reward.”
Institutions like mutual funds may have heeded such warnings. Asset managers moved away from momentum in the first quarter, and slightly reduced their negative exposure to value stocks. Still, both groups remain invested in past winners and against value. Rarely if ever does the aggregated hedge fund position bet against momentum, according to Banerji.
“A proven model over the past five years, despite many of the headlines, is that crowded hedge fund names tend to outperform,” Dunn said. “It’s going to be hard for contrarian guys to stick their hands out there when momentum worked so well for so long. You can’t change a zebra’s stripes — they’re going to do what they got paid for in the past.”