Goldman warns hedge fund outperformance holds crowding risk
August 22 2019 12:13 AM
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The European headquarters of Goldman Sachs Group in London. Equity hedge funds are enjoying their strongest performance since 2009, with the S&P 500 index up 16% this year, but Goldman Sachs warns that crowding is a risk.

Bloomberg /Singapore

Equity hedge funds are enjoying their strongest performance since 2009,  with the S&P 500 index up 16% this year, but Goldman Sachs Group Inc warns that crowding is a risk.
Funds have benefited from both a rising stock market and successful stock selection, strategists including Ben Snider and David Kostin wrote in a note on August 20. 
They’ve also concentrated their holdings into a reduced number of industries, such as health care, and into single names, particularly Amazon.com Inc.
When rallies peak, too much professional money can try to get out of the same stocks simultaneously and exaggerate declines. Goldman Sachs Group Inc warned that crowding is a risk for equity investors in hedge funds.
“Funds continue to lift portfolio weights in their top positions, which are increasingly also the top positions of other funds,” the strategists wrote. “These dynamics, along with higher leverage, lower portfolio turnover, and declining market liquidity, have boosted the performance of momentum stocks while also increasing the risk funds face from crowding.” 
They added that this will “make funds particularly vulnerable to a potential market unwind, particularly if accompanied by the decline in liquidity that typically coincides with falling risk appetite.” Investment banks from Goldman to Morgan Stanley increasingly study the relative positioning of funds that compete with each other to beat benchmarks. The crowding issue is in focus this month, as August has seen a spike in stock and bond markets volatility. Hedge funds rushed for safety last quarter as Treasuries rallied and concerns about economic slowdown flared, regulatory filings compiled as of last week showed.
Goldman found the most popular long positions had lagged the S&P 500. The favourite short positions trailed by even more. Overall, the average equity fund return in 2019 has been 9%.
Alongside the success comes some concern as well, after examining the holdings of 835 hedge funds with $2.1tn of gross equity positions at the start of the third quarter.
Goldman found a rotation continued from technology into health care, which is now the sector with the largest overweight versus the Russell 3000 Index, which like the S&P 500, is also up 16% this year.
Overweights in health care and industrials are at a 10-year high, the report said. Funds trimmed positions in semiconductors and “other stocks exposed to US-China trade conflict,” according to the strategists.
Also, late June and July saw a sharp rise in exposures as the Federal Reserve began to cut rates and US-China trade relations appeared to thaw, the strategists said. But leverage has been trimmed again in August.
Amazon.com appeared most frequently among the 10 largest holdings of funds, followed by Facebook Inc. New names on the list of the top 50 such stocks include Allergan Plc and Micron Technology Inc.



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