It has already been an abysmal year (and decade) for hedge funds in particular, and active asset managers in general. But how abysmal?
According to Bank of America, “just 18% of large cap funds outperformed the Russell 1000 in 1H16, so far making it the worst year for active funds in history (since ’03).”
As Savita Subramanian notes, the average fund was up 0.8%, but lagged its benchmark by 3ppt. Crowded positions proved particularly damning: the 10 most crowded stocks lagged the 10 most neglected by 18ppt in the 1H, an atypically high spread. While intra-stock correlations had been trending down for most of the year, they spiked again in the period surrounding Brexit as macro came back into focus. Long-short alpha opportunity also remained scarce, another challenge to stock pickers.
What did the best-performing funds do right? Concentration was key: funds with fewer holdings, high active share (big stock positions) but with no big sector positions outperformed (Table 1 inside).
Another problem: rising correlations meaning the market remains a highly clustered “macro market”, with little dispersion: “Correlations rose in June to 35.0% as macro risk remained in focus. This makes the environment more challenging for active managers when stocks are more correlated with one another.”
Another big danger: positioning, and specifically what may be the pain trade of the third quariter:
The reaction of stocks to Brexit was eerily similar to the past – the market pulled back slightly over 5%– in-line with the median peak to trough decline of 6% during historical non-US macro shocks — but recovered quickly. Active managers are more overweight US stocks exposed to Europe than stocks exposed to any other region, including pure domestic exposure. If Europe or UK-exposed companies begin to guide down on Brexit, this could be the 3Q pain trade. S&P 500 stocks with the highest UK sales exposure have underperformed the index by 10ppt YTD (and by 4ppt since Brexit).
Admittedly, not all companies with Europe sales exposure will be impacted negatively by weaker European GDP growth anticipated by our economists, but these have been some of the most punished stocks post-Brexit and are vulnerable to further downside risk if negative sentiment around Brexit continues.
As we showed two weeks ago (and also 3 years ago) the best strategy remains a simple one: doing the opposite of whatevery one is doing, and going long the most hated names:
Once again, positioning mattered, crowded positions proved particularly damning in 1H, with the 10 most crowded stocks underperforming the 10 most neglected stocks by 18ppt, an atypically high spread. potential contributor to this performance is the continued flow of funds into passive vs active strategies.
So to answer the question posed by the title: why are active managers having the worst year in history? Simple – because they are all doing the same thing.
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And with active managers now a constant humiliation to their profession, what does this mean? Here is BofA’s damning assessment:
Activist campaigns, self-help via spin-offs/divestitures, buybacks and deals were rewarded by investors for most of the post-crisis era. But these drivers are now destroying alpha, as investors grow less enamored of catalyst-driven opportunities, are more worried about balance sheets, and want to see organic growth. With deals being struck at higher multiples, and buybacks executed at higher prices, acquirers have underperformed this year, and share buybacks have lagged for over two years.
The conclusion: “This smacks of a late stage bull market: the levers of cheap financing and corporate re-tooling have been largely exhausted.”
One can be sure, however, that the Fed – both the reason why everyone is underperforming and the reason why stocks are still as artificially as high as they are – will not go down quietly.
via http://ift.tt/29ObUK8 Tyler Durden