Business

Hedge Fund Crowding Costs: Q3 2015

Applying a robust risk model to hedge fund holdings data helps avoid losses and yields profitable opportunities. In this article, we highlight the sectors with the largest Hedge Fund losses due to crowding in Q3 2015, which sum to $4 billion. Our methodology provides an early-warning system for losses in crowded names. This analysis also identifies crowded stocks beaten up by hedge fund liquidations, which tend to mean-revert.

Analyzing Hedge Fund Sector Crowding

Our edge comes from a central thesis: the most crowded stocks are those that contribute the most to hedge fund stock-specific volatility (volatility of alpha). Furthermore, the direction of this alpha (positive or negative) is a leading indicator. A robust analysis of the AlphaBetaWorks Statistical Equity Risk Model allows us to identify stocks that are the highest contributors to stock-specific volatility for hedge funds in each sector.  These are the most crowded stocks that stand to benefit the most from accumulation and stand to lose the most from liquidation.

While a static crowding analysis using our risk model provides valuable insights, we go further by identifying Hedge Fund Aggregate Sector Alpha – the alpha (stock-specific performance) of aggregated hedge fund portfolios by sector.  This makes the analysis dynamic: If Hedge Fund Aggregate Sector Alpha is trending up, capital is flowing into crowded stocks. Conversely, if it is trending down, capital is flowing out of crowded stocks – often abruptly. Yes, crowding is good at some times and bad at others.  Further, Hedge Fund Aggregate Sector Alpha trends persist for months and years, providing advanced notice of losses. Importantly, crowded stocks hit hard by liquidations tend to mean-revert: the worst risk-adjusted performers often become attractive long opportunities.

Hedge Fund Sector Aggregates

We create aggregate portfolios of hedge fund positions in each sector. Each such sector portfolio is a Hedge Fund Sector Aggregate within which we identify the highest contributors to security-specific (residual) volatility (the most crowded stocks). This follows the approach of our earlier articles on hedge fund crowding.

The Hedge Fund Sector Aggregate Alpha (?Return, residual, or security-specific return) measures hedge fund security selection performance in a sector. It is the return HF Sector Aggregate would have generated if markets had been flat. ?Return can indicate accumulations and liquidations.

The AlphaBetaWorks Statistical Equity Risk Model, a proven tool for forecasting portfolio risk and performance, estimated factor exposures and residuals. Without an effective risk model, simplistic crowding analyses ignore the systematic and idiosyncratic exposures of positions and typically merely identify companies with the largest market capitalizations.

Sectors with the Largest Losses from Hedge Fund Crowding

During Q3 2015, hedge funds lost $4 billion to security selection in the five sectors below. Said another way: if hedge funds had simply invested passively with the same risk, their sector long equity portfolios would have made $4 billion more. The monthly losses are listed (in $millions) below:

7/31/20158/31/20159/30/2015Total
Other Consumer Services-101.16-113.93-312.84-426.77
Oil and Gas Pipelines472.21-465.63-10.29-475.93
Specialty Chemicals-155.87196.41-730.73-534.32
Oil Refining and Marketing262.69-167.15-388.52-555.67
Semiconductors-240.71-1,422.70-660.95-2,083.65

The Semiconductor Sector was particularly painful for hedge funds in Q3 2015, which we examined in a previous article.

Below we provide our data on three of the above sectors: historical Hedge Fund Sector Alpha and the most crowded names.

Specialty Chemicals – Hedge Fund Alpha and Crowding

Hedge Fund Specialty Chemicals Security Selection Performance

Hedge Fund Specialty Chemicals Sector Aggregate Historical Security Selection Performance

Hedge Fund Specialty Chemicals Crowding

Chart of the stock-specific hedge fund crowding the cumulative contributors to the residual variance of Hedge Fund Specialty Chemicals Sector Aggregate Portfolio relative to Market

The following table contains detailed data on these crowded holdings:

Exposure (%)Net ExposureShare of Risk (%)
HF Sector Aggr.Sector Aggr.%$milDays of Trading
GB:PAHPlatform Specialty Products Corp.17.592.5215.071,351.814.344.62
APDAir Products and Chemicals, Inc.47.4613.8933.573,010.813.722.09
LYBLyondellBasell Industries NV3.3623.03-19.67-1,764.2-5.914.04
GRBKGreen Brick Partners, Inc.2.990.252.74245.779.710.58
GRAW. R. Grace \& Co.11.763.458.32745.811.02.99
PXPraxair, Inc.0.3116.29-15.98-1,433.5-5.92.21
AXLLAxiall Corporation2.791.201.59142.84.50.74
TROXTronox Ltd.1.800.451.35121.214.20.36
ARGAirgas, Inc.0.193.77-3.59-321.8-4.10.33
SIALSigma-Aldrich Corporation3.327.88-4.56-408.6-2.30.28
NEUNewMarket Corporation0.232.61-2.38-213.4-6.00.26
VHIValhi, Inc.0.020.91-0.88-79.2-240.20.26
CYTCytec Industries Inc.0.072.04-1.97-176.5-2.00.18
ASHAshland Inc.1.663.89-2.23-200.0-2.40.18
POLPolyOne Corporation0.191.65-1.46-131.2-4.30.10
TANHTantech Holdings Ltd.0.000.19-0.19-17.3-2.70.09
BCPCBalchem Corporation0.000.82-0.82-73.4-8.80.07
CBMCambrex Corporation0.060.65-0.59-53.2-2.10.06
CMPCompass Minerals International, Inc.0.151.31-1.16-104.0-4.80.06
Other Positions0.290.51
Total100.00

Oil Refining and Marketing – Hedge Fund Alpha and Crowding

Hedge Fund Oil Refining and Marketing Security Selection Performance

Hedge Fund Oil Refining and Marketing Sector Aggregate Historical Security Selection Performance

Hedge Fund Oil Refining and Marketing Crowding

Chart of the stock-specific hedge fund crowding the cumulative contributors to the residual variance of Hedge Fund Oil Refining and Marketing Sector Aggregate Portfolio relative to Market

The following table contains detailed data on these crowded holdings:

Exposure (%)Net ExposureShare of Risk (%)
HF Sector Aggr.Sector Aggr.%$milDays of Trading
MWEMarkWest Energy Partners, L.P.18.235.3112.92848.96.131.86
VLOValero Energy Corporation0.3816.06-15.68-1,030.4-2.723.34
TSOTesoro Corporation14.325.368.96589.01.412.74
TRGPTarga Resources Corp.8.992.526.47425.38.77.76
PSXPhillips 669.2121.86-12.66-831.8-2.86.03
PBFPBF Energy, Inc. Class A6.801.235.56365.67.85.84
NGLSTarga Resources Partners LP8.743.525.21342.76.22.84
WGPWestern Gas Equity Partners LP3.586.63-3.05-200.5-7.42.06
MPCMarathon Petroleum Corporation9.5914.34-4.75-312.0-1.11.81
TLLPTesoro Logistics LP5.122.332.79183.13.51.45
HFCHollyFrontier Corporation1.294.22-2.93-192.3-1.41.11
WNRWestern Refining, Inc.0.212.10-1.89-124.5-1.40.61
IOCInteroil Corporation0.661.50-0.84-55.3-6.90.49
GELGenesis Energy, L.P.4.352.202.15141.16.20.34
ENBLEnable Midstream Partners LP0.391.73-1.34-88.2-31.60.33
EMESEmerge Energy Services LP0.010.43-0.42-27.6-6.10.29
DKDelek US Holdings, Inc.0.001.07-1.07-70.0-1.20.26
WNRLWestern Refining Logistics, LP1.570.361.2179.515.00.24
ALJAlon USA Energy, Inc.0.000.67-0.67-44.1-2.30.18
NSNuStar Energy L.P.3.502.331.1776.91.40.15
Other Positions0.070.28
Total

Semiconductors – Hedge Fund Alpha and Crowding

Hedge Fund Semiconductor Security Selection Performance

Hedge Fund Semiconductors Sector Aggregate Historical Security Selection Performance

Given the magnitude of recent semiconductor sector liquidations and the record of mean-reversions, the following crowded hedge fund semiconductor bets may now be especially attractive:

Hedge Fund Semiconductor Crowding

Chart of the stock-specific hedge fund crowding the cumulative contributors to the residual variance of Hedge Fund Semiconductors Sector Aggregate Portfolio relative to Market

The following table contains detailed data on these crowded holdings:

Exposure (%)Net ExposureShare of Risk (%)
HF Sector Aggr.Sector Aggr.%$milDays of Trading
SUNESunEdison, Inc.33.181.8231.362,550.99.686.72
MUMicron Technology, Inc.18.873.9514.931,214.12.98.85
INTCIntel Corporation3.7227.94-24.22-1,970.2-1.62.01
SEMISunEdison Semiconductor, Inc.3.220.143.08250.752.50.38
SWKSSkyworks Solutions, Inc.0.043.85-3.82-310.4-0.90.38
TXNTexas Instruments Incorporated0.0910.38-10.28-836.6-1.90.32
NXPINXP Semiconductors NV7.904.413.49283.61.00.29
AVGOAvago Technologies Limited3.296.69-3.40-276.3-0.50.18
FSLFreescale Semiconductor Inc0.022.40-2.38-193.5-5.20.17
ONON Semiconductor Corporation3.390.972.42196.64.30.08
MLNXMellanox Technologies, Ltd.1.890.431.45118.30.70.08
BRCMBroadcom Corporation Class A7.815.512.30187.20.50.07
MXMagnaChip Semiconductor Corporation0.920.050.8770.931.20.07
ADIAnalog Devices, Inc.0.053.90-3.85-312.9-1.70.06
QRVOQorvo, Inc.1.132.32-1.19-96.7-1.10.06
NVDANVIDIA Corporation0.582.10-1.51-123.1-0.40.04
GB:0Q19CEVA, Inc.1.250.081.1795.530.70.04
MRVLMarvell Technology Group Ltd.0.041.32-1.28-104.4-0.90.03
MXIMMaxim Integrated Products, Inc.0.341.90-1.56-126.9-1.70.02
MXLMaxLinear, Inc. Class A0.740.120.6250.62.80.02
Other Positions0.360.13
Total

Conclusions

  • Data on the crowded names and their alpha can reduce losses and provide profitable investment opportunities.
  • A robust and predictive equity risk model is necessary to accurately identify hedge fund crowding.
  • Allocators aware of crowding can gain new insights into portfolio risk, manager skill, and fund differentiation.
  • Crowded bets tend to mean-revert following liquidation: the worst risk-adjusted performers in a sector become the best.
The information herein is not represented or warranted to be accurate, correct, complete or timely.
Past performance is no guarantee of future results.
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