Hedge funds that hunkered down after GameStop are actually lacking out on market positive aspects

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Hedge funds are nonetheless licking their wounds after a retail buying and selling frenzy compelled 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 huge 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 response to 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 to this point on common, in response to RBC’s evaluation of 330 hedge funds based mostly on the latest regulatory filings.

“It’s partly resulting from 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 means of mid February.”

In the meantime, newbie retail merchants, typically scolded for his or her lack of sophistication in comparison with Wall Avenue execs, 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 most well-liked hedge fund lengthy positions by eight proportion factors and the S&P 500 by 4 proportion factors, in response to Goldman.

This David versus Goliath battle got here at a very susceptible time for hedge funds. Skilled merchants had already gotten caught in an enormous market rotation out of their tech darlings and into cyclical names amid an financial restoration. Development-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.

Document leverage

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 internet and gross publicity on report, in response to Goldman.

“The January brief squeeze illustrated how the mix 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, Fb, 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 brought on by the GameStop mania, mentioned in a Feb. 10 letter to buyers that he at all times felt extra comfy with greater internet and decrease gross publicity, which means his fund tends to have greater lengthy positions than brief.

Loeb additionally mentioned he discovered his lesson betting in opposition to names with outsized brief curiosity.

“After a couple of earlier painful experiences of our personal taking positions in opposition to corporations with massive brief pursuits, we had a preview of what can occur and reduce our losses,” he mentioned within the letter.

— CNBC’s Michael Bloom contributed reporting.

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