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Goldman: Hedge Funds Short Financials

Date: Thursday, June 5, 2008
Author: Emma Trincal, Senior Financial Correspondent, Hedgeworld.com

 NEW YORK (HedgeWorld.com)—A new report from Goldman Sachs Group Inc. found that hedge funds are net short financial stocks, which was to be expected as losses and asset write-downs continue to take their toll on banks this year. What's notable though is that hedge funds were still overly long the sector as recently as the end of last year, according to the quarterly Hedge Fund Trend Monitor, released on May 20 and co-authored by David Kostin, chief U.S. investment strategist who recently succeeded Abby Joseph Cohen.

Based on an analysis of 755 hedge fund filings with $833 billion of long equity positions, the report showed that net long hedge fund holdings in financials fell by $20 billion in the first quarter of this year from the fourth quarter of 2007, while hedge fund short positions in this sector rose during the first quarter by an estimated $7 billion. This suggests, according to the report, that hedge funds in the first quarter were 9% net short financial stocks, compared with 14% net long in December and 26% net long at the end of the third quarter of last year.

Several research papers and databases quantify the distribution of hedge fund strategies based on amounts of dollars invested. But few initiatives focus on the long holding positions hedge funds report in filings with the Securities and Exchange Commission. Thus for this research, Goldman Sachs examined 13-F filings, the quarterly reports in which institutional investment managers must disclose the names and numbers of shares of their top holdings in accordance with the Securities and Exchange Act of 1934.

The Hedge Fund Trend Monitor report sliced hedge fund long assets into several investment strategies. It found that equity long/shorts represented 34% of the overall $833 billion invested in long equity positions. Multi-strategy funds accounted for 25% of hedge fund long equity assets; and event-driven represented 13% of the total; leaving the remaining 22% to other types of strategies, such as distressed, short-biased and others.

In this report, Goldman shed light on another type of analysis: the distribution of sector allocation by hedge fund investment strategy. According to this research, equity long/short funds appear the most tilted toward information technology, with 21% of their long assets in this sector. Global macro players appear the least invested in information technology, with 14% of their long assets in the sector. Event-driven managers are most active in the consumer sector, with 20% of their long positions invested there. It is likely that those funds are attracted to the numerous merger and acquisitions possibilities in this sector.

The report also identified the 20 most popular stocks held by two types of hedge funds: equity long/short and event-driven.

For equity long/short funds, the first stock was QUALCOMM Inc., which amounted to 28% of the long positions. It was followed by Microsoft Corp. (12%), Apple Inc. (22%) and Google Inc. (19%).

Not surprisingly, the most popular stock among event-driven hedge funds was Yahoo! Inc., amounting to 34% of the positions. It was followed by Clear Channel Communications Inc. (22%).

One piece of advice from the authors of the report is to make filings data investable. They recommend buying what they call the Hedge Fund VIP List, meaning "very important positions," rather than "persons." This basket of stocks aggregated by Goldman under the Bloomberg ticker consists of 50 stocks that "matter most to hedge funds." By that, the Goldman analysts who compiled the research mean the stocks that appear the most often among the top 10 holdings of hedge funds with 10 to 200 positions, with data collected from 13-F filings.

The Hedge Fund VIP basket outperformed the market not only for the first quarter of 2008 but for the year-to-date. As of May 20, when the report was released, the VIP strategy was 3.2% for the year, outperforming the Standard & Poor's 500 stock index by a 5 percentage points.

In addition, the basket of the 50 stocks that "matter most to hedge funds" has outperformed the S&P 500 by 102 basis points on a quarterly basis since 2001, according to the report. The VIP List, according to Goldman, "offers an efficient vehicle for investors that are looking to follow the smart money based on 13-F filings."

The report also offered insight regarding hedge fund short exposures. Hedge funds account for the vast majority of shorts in the U.S. equity market, with 85% of all short positions, or $558 billion, at the end of March.

The analysis suggested that the typical hedge fund increased its short exposure during the first quarter. Hedge funds operated 35% net long in the first quarter, compared to 44% at the end of 2007. The large majority of hedge fund short positioning was conducted via single stocks, not exchange-traded funds or indexes.

However, short selling is evolving. While the steady growth of shorts in the U.S. stock market this decade has accompanied the rise in hedge fund assets, Goldman predicted that in the future, mutual funds may make up a larger share of the short market, given recent initiatives such as 130/30 programs.