Hedge Fund Crowding - Q1 2020 Update

One of our more popular Factor Spotlights of 2019 centered around hedge fund crowding. As we head into another earnings season, we wanted to revisit the topic as it pertains to a few key industries.

As a reminder, we shared a 2019 paper that posited that the level of concentration has been consistently on the rise, stemming from three key reasons:

1. The number of public companies has been essentially cut in half over the past 20 years
2. The number of fund managers has increased over that same time
3. As smaller managers have found it more difficult to raise capital, bigger managers have dominated the equity markets - typically holding much larger positions in their ideas

We need to look no further than the Momentum crash of September 2019 to understand how much danger is inherent to the combination of a crowded trade plus a large factor move.

Using Wolfe Research’s data, we can see how this factor has performed over time. This is what cumulative return has looked like for HF Concentration over the past 12 months:

As we can see, while cumulative return was up 2% during that time, there were times that the factor sold off, most notably in early December, at the end of September, and from mid-May to June of last year.

A good barometer of sector crowding is the Goldman Sachs Hedge Industry VIP ETF, the composition of which currently looks like this:

Using Omega Point’s Security Search tool, we can find the most crowded names in the model universe that have significant idiosyncratic risk, with the following criteria:

Country: United States
Idiosyncratic Risk: Minimum 67%
Liquidity: Minimum $5mm ADTV

The idiosyncratic risk requirement is enforced so we can identify those names that have the highest susceptibility to a sharp sell-off or rally after a negative or positive earnings surprise.

We then screened for the top 3 crowded names in each of the sectors at the GICS 1 level. Bear in mind that the HF Crowding exposure score is the beta to the return of the HF Crowding factor, and the model winsorizes the score, so 5 is the highest score possible. As an example. TEUM has a HF Crowding score of 5, which means that in an environment where the factor was up 2% in the past year, TEUM was up 10%.

Also please note that there were no companies in the Financials sector that possessed high beta to HF Crowding, and there was only one company in the Utilities sector that qualified.

Armed with this information, Omega Point and Wolfe Research can help managers avoid big blowups in concentrated names, allowing them to follow the factor’s ongoing trend, evaluate exposure to it at the portfolio or single security level, and better understand the factor’s relationship to other factors.

US & Global Market Summary

US Market: 1/10/20 - 1/16/20

• The US and China signed a phase-one trade deal on Wednesday, and the market continued to see positive movement (with the Dow hitting a record after the deal was signed). Investors generally agree that the icy relationship between the two countries still has a long way to go.
• Long-dated U.S. Treasury yields rose on Friday after the U.S. Treasury Department announced (as had been well telegraphed) that it will issue a 20-year nominal coupon bond in 1H2020 to finance a federal deficit that is edging close to 5% of GDP.
• Earnings season has commenced, with most of the banks posting strong results (JPM had a record quarter), citing the strong current state of the US consumer.

‍Factor Update: US Model

• Profitability was the week’s biggest winner, continuing its ascent away from Oversold territory
• Growth continued to see positive normalized gains, and remains Overbought
• Momentum now sits at Neutral after a recent peak of +1.31 SD above the mean on 12/9
• Volatility fell from a Jan 2 high of +1.59 SD above the mean, and is about to exit Overbought space
• Earnings Yield has continued to sell off and is on the cusp of becoming Extremely Oversold at -1.89 SD below the mean
• The rally in Value ended abruptly, as it lost a massive 0.64 standard deviations and sits close to Neutral now
• US Total Risk (using the Russell 3000 as proxy) fell by 0.07%

‍Factor Update: Worldwide Model

• Global Growth again saw the biggest climb, +0.54 SD in the past week and now officially Overbought
• Exchange Rate Sensitivity continued to see gains after surpassing the mean last Friday
• Earnings Yield continued its plummet, and now sits on the edge of an Extremely Oversold designation.
• Value also took a big hit worldwide, and has fallen from a recent high of +2.01 SD above the mean on 12/26, and is no longer an Oversold factor
• Global Risk (using the ACWI as proxy) decreased by 12bps

Regards,
Omer