FT : Hedge funds with crowded positions feel the pressure

Hedge funds with crowded positions feel the pressure

Anne Ford on the ugly downside to managers falling in love with the same stocks

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”
Charles Mackay,
Extraordinary Popular Delusions
and the Madness of Crowds, 1841

Hedge fund investors have been in the doldrums lately.
Since market volatility increased last summer after a period of relative calm, hedge fund managers have been whipsawed around trying to navigate choppy waters.
The HFRI Composite index has fallen 4 per cent since the second quarter of 2015, underperforming the S&P 500 index by 6 per cent, and started 2016 off with the worst January since 2008.
While those returns are poor, they are by no means the worst of it. Funds that piled into the most crowded hedge fund names were hit much harder. According to data compiled by Bloomberg since July 2015, stocks in which hedge funds had the largest ownership percentage in the Russell 3000 index fell a whopping 31 per cent.
For investors in multi-manager portfolios with overlapping exposures, the effects were amplified as they sometimes doubled down unintentionally on these crowded names.
In a benign market environment, duplicated positions are not uncommon and are, perhaps, inevitable. In fact, if managers are drawn to the same stocks, it may validate the investment thesis and can be a positive for investors.
The ugly downside to managers falling in love with the same stocks is that it contributes to liquidity risk in times of market stress. When hedge fund managers who own a large portion of the total trading volume are all trying to sell at the same time, it becomes a vicious cycle of de-risking regardless of fundamentals.
This is what happened in February when hedge funds experienced the worst 10-day period of relative performance since 2011 and found themselves held hostage as they blew through their risk parameters.
Given the recent turmoil, some investors are surmising that the bloated hedge fund industry has lost its way, with too much capital chasing too few ideas. The industry is now roughly $3tn in size, having grown considerably since the financial crisis.
Other investors have the exact opposite claim, pointing out that recent hedge fund redemptions have created forced selling and reduced liquidity for investors in crowded hedge fund names.
A March 15 Bloomberg article pointed out that hedge fund clients of Bank of America sold a net $3.5bn in equities so far this year, larger than any other type of seller.
The reality is that investors crowding into popular stocks is nothing new. When the markets are ripping, investors are happy to follow the “smart money” trades on the way up, even if they are crowded.
Over time, it has been beneficial to invest in the most popular stocks. Goldman Sachs’s Equity Research Group maintains a hedge fund VIP basket that tracks the 50 most popular hedge fund long positions.
Since 2001, to February 19, the VIP list has outperformed the S&P 500 index in 64 per cent of quarters by an average of 56 basis points, or 225bp annualised.
Regardless of the long-term positives, investors can get burnt in the short term by crowded trades as managers de-risk and head for the exit. The GS VIP was hurt in 2002, 2008, 2011 and 2015, all periods when volatility spiked in times of economic stress.
With uncertainty over US interest rate policy, Chinese growth and oil prices, volatility could remain elevated in the near term, putting hedge funds with crowded positions under further pressure.
Investment advisers and multi-manager strategies such as fund of funds will also be under pressure as they struggle to justify their fees and prove that they are avoiding “group think”.
It will be ever more important for advisers to look under the hood of hedge funds, performing robust diligence to understand their managers’ thought processes. It is not enough to just rubber stamp a manager because they have sizeable assets and are well known in the industry.
The key is finding those who have real conviction in their investments and avoid those who have made a name by simply following the herd.

WSJ : Saudi Arabia Dismisses Its Powerful Oil Minister Ali al-Naimi

Saudi Arabia Dismisses Its Powerful Oil Minister Ali al-Naimi

Departure is part of wider government reshuffle, with Saudi Aramco chief Khalid al-Falih succeeding him.

RIYADH—Saudi Arabia dismissed its long-serving oil minister Ali al-Naimi on Saturday, marking the departure of one of the industry’s most powerful figures, as the country grapples with weak oil prices.

Mr. Naimi, who had been the kingdom’s oil minister since 1995, has been a strong voice against lowering Saudi Arabia’s production when prices fall, a move away from its past tactics. He moved the Organization of the Petroleum Exporting Countries to keep pumping oil at a rapid clip despite a global supply glut, a decision that has weighed on crude-oil markets and depressed prices.

He will be succeeded by Khalid al-Falih, chairman of state oil company Saudi Arabian Oil Co., better known as Saudi Aramco.

Mr. Naimi, reached on his cellphone, declined to take questions. Mr. Falih couldn’t be reached for comment.

The royal decree, announced via state media, was part of a wider government reshuffle that includes a restructuring of the oil ministry, which has been renamed the Ministry of Energy, Industry and Mineral Resources. It comes less than two weeks after Saudi Arabia unveiled an ambitious economic reform program aimed at reducing the kingdom’s dependence on oil revenue.

The collapse of oil prices has hit the world’s biggest energy companies hard and has hurt the budgets of oil-dependent countries. In Saudi Arabia, the world’s largest oil exporter, petroleum accounted for almost three-quarters of state revenues last year.

The 80-year-old Mr. Naimi had for some time wanted to retire. His departure and Mr. Falih’s appointment were widely expected, suggesting market reaction to the moves is likely to be calm, said Jason Bordoff, director of Columbia University’s Center on Global Energy Policy.

“Khalid al-Falih has been a key part of the team making these decision for many years,” he said. “It represents a continuation of the path they’ve been on.”

Mr. Falih has been within the inner circle of Saudi oil policy-making for a long time. He was being groomed for the top post for months, according to people familiar with the matter. The decree said Mr. Falih was relieved from his other post of health minister.

Jim Krane, a fellow at Rice University’s Baker Institute, said Mr. Falih’s appointment to head an oil ministry broadened to include electricity and other resources would allow the kingdom to better coordinate its domestic energy policy with its oil export policy. In the past, the two have often worked at cross-purposes, as domestic consumption of heavily subsidized energy has risen, undermining the state oil company’s ability to expand exports.

Saudi Arabia’s powerful Deputy Crown Prince Mohammed Bin Salman has already pushed through cuts in those subsidies, effectively raising the price of gasoline and other fuels for Saudi citizens. Meanwhile, the kingdom has expanded its refining capacity, creating new internal demand for crude oil.

“They need a ministry that can take a more holistic approach to energy in the kingdom,” Mr. Krane said. “They’re working to rationalize their energy policy.”

Mr. Naimi, known in oil industry circles as a technocrat’s technocrat, appeared to be losing his grasp on power when a meeting of major oil producers aimed at reaching an output-freeze agreement collapsed less than a month ago.

The Saudi oil ministry had signaled it was ready to reach a deal with counterparts from Russia, Qatar and Venezuela to freeze their output at January levels. But the efforts were scuttled because the prince wasn’t willing to agree to a deal that didn’t include Iran, which had said it wouldn’t participate as it ramps up output following the end of Western sanctions over its nuclear program.

“It was very clear that Naimi was being overruled by a royal for the first time in two decades and that was a very humbling experience for him,” said an oil minister who attended the meeting.

For Mr. Naimi, that marked the end, according to one of his assistants. “We all knew after the Doha meeting that it was only a matter of time before he is gone,” one of Mr. Naimi’s assistants said.

Throughout his career, Mr. Naimi has worked to avoid a repeat of the mistake of one of his predecessors, Sheikh Zaki Yamani, who was dismissed in 1986 as he unsuccessfully tried to fight an oil-price collapse by unilaterally reducing Saudi output.

Mr. Naimi was named oil minister in 1995 by Saudi King Fahd bin Abdulaziz Al Saud. He took office at an uncomfortable time for the kingdom and OPEC, which it dominates. At the time, depressed oil prices had failed to rise enough to save oil producers from a continuing cash crisis.

But Mr. Naimi soon carved out an identity and transformed himself from a competent manager into one of the world’s key economic policy makers.

As de facto head of OPEC, among the first changes Mr. Naimi made was to turn its periodic gatherings into corporate-style events. He was often successful at achieving Saudi Arabia’s goals, while managing the expectations of those of adversaries within OPEC, such as Iran and Venezuela.

The jury is still out on Mr. Naimi’s signature policy of keeping the spigots open during periods of low prices. Prices fell farther and faster than many in Saudi Arabia expected, hitting a 13-year low in January of about $27 a barrel.

At a conference in Houston in February, Mr. Naimi said the kingdom was prepared for oil prices below $20 a barrel and wouldn’t change its strategy soon. The country is producing near-record production of more than 10 million barrels a day.

Mr. Naimi reasoned that a period of low prices is needed to force producers that rely on high prices to cut back.

When asked when the supply glut would end, he said: “When? I don’t know, but it’s going to end.”

WSJ : Saudi Arabia’s King Salman Shakes Up Government Ministries

Saudi Arabia’s King Salman Shakes Up Government Ministries

Changes coincide with a plan to reduce dependence on oil and boost foreign investment

RIYADH—Facing low oil prices and diminishing foreign-exchange reserves, Saudi Arabia’s King Salman has shuffled top policy makers, including his long-serving oil minister and central-bank governor.

The sweeping changes announced Saturday coincide with a plan to reduce Saudi Arabia’s dependence on oil and boost foreign investment, as well as other sources of revenue such as tourism. The plan, announced last month by the king’s 30-year-old son, Deputy Crown Prince Mohammed bin Salman, marks the kingdom’s most ambitious effort yet to overhaul its economy and shift away from oil, which accounted for more than 70% of government revenue last year.

Saturday’s shuffle was also the latest in a rapid wave of changes led by King Salman and his son since the king ascended to the throne in January 2015. The government has slashed its spending and announced cuts in subsidies for fuel, water and electricity.

While many of these changes were long overdue, the prolonged period of cheap oil and an employment rate of 11.7% has put more strain on the state’s finances and added a sense of urgency to the monarchy’s actions.

“The changes are natural, given the economic shifts announced by Prince Mohammed bin Salman in April,” said Simon Kitchen, strategist at Cairo-based EFG Hermes.

The kingdom is expected to announce a detailed package of reforms in late May or early June.

Oil minister Ali al-Naimi , who has served in that position since 1995, was replaced with Khaled al-Falih, chairman of the national oil company Aramco. The ministry has also been renamed to become Ministry of Energy, Industry and Mineral Resources. Mr. al-Naimi will become an adviser to the royal court.

Mr. al-Falih had served until Saturday as health minister, before being replaced in the shuffle with Tawfiq al-Rabia, the former minister of commerce. New ministers for transportation, hajj, and social affairs were also appointed.

In a key change at the central bank, Governor Fahad al-Mubarak was replaced with Ahmed al-Khelaify, who has been serving as the bank’s deputy governor for research and international affairs.

Mr. al-Mubarak had come under intense pressure in recent months amid fast dwindling foreign-exchange reserves and rising bets against the local currency’s peg to the U.S. dollar.

The riyal is fixed at roughly 3.75 to the dollar, but one-year forward contracts hit multiyear highs in the past months on speculation that the kingdom will be forced to let go of the nearly 30-year old peg to better manage a fiscal deficit that widened to a record of nearly $98 billion last year.

A sharp fall in the price of oil since the middle of 2014 has put immense pressure on Saudi Arabia’s petrodollar-dependent economy. Its foreign-exchange reserves declined to $587 billion at the end of March, down more than 21% from a peak of $746 billion in August 2014, according to the latest central-bank data. It spends billions to maintain the currency peg, according to analysts.

Saudi Arabia’s currency peg has worked well in the past, giving it stability as it enjoyed a decade of expensive oil, a commodity priced in dollars and the kingdom’s main revenue earner. But that income has slumped, straining the kingdom’s finances. Abandoning the peg would stretch those dollars because the riyal would weaken.

Most analysts, however, don’t see the country abandoning its peg in the near to mid term, as repayment costs for households and companies that have borrowed in foreign currencies would rise in local-currency terms. And inflation would likely soar due to a rise in the price of imports.

Spearheading the response to these challenges has been Prince Mohammed, who also heads the country’s Council of Economic and Development Affairs, a government body created last year with a mandate of handling domestic policy.

The plan—dubbed Saudi Vision 2030—aims to make investment replace oil as the main source of revenue by creating what officials described as the world’s largest sovereign-wealth fund.

In a step to increase the number of visitors to Saudi Arabia, the Ministry of Hajj has been renamed to become the Ministry of Hajj and Umrah, an indication of a new focus on religious tourism. Umrah, also known as the lesser pilgrimage, is seen as a potentially lucrative field for the kingdom, which was host to around eight million umrah pilgrims last year. Saudi Arabia wants to increase that number to 15 million by 2020.

The king also established two new commissions for culture and entertainment, another area where Saudi decision makers see potential for growth in a country that still doesn’t allow movie theaters.

As part of the restructuring, the king canceled the Ministry of Water and Electricity. Management of the kingdom’s scarce water resources will move to the Ministry of Agriculture, which has been renamed to become the Ministry of Environment, Water and Agriculture.

Weekly Update

Weekly Market Update: Downside Risks Trump Recovery Hopes


Over recent weeks there has been a recurring debate in markets about the prospects for the stalled global economic recovery. Many analysts saw the first quarter as a seasonal aberration and predicted the widespread economic softness would soon to be replaced by green shoots as oil prices rose, China stabilized and the US economy improved. The more pessimistic analysis said the problems seen in the first quarter were indicative of deeper problems, and developments this week seemed to favor the latter camp. The April US jobs report was soft, and the decline in the April US ISM factory data suggested manufacturing was not healing quite as quickly as expected. Other global data was similarly weak. The softer dollar trend appears to have plateaued, with EUR/USD unable to sustain gains above 1.1500 while the USD/JPY appears to holding above 105. A resurgent Dollar weighed on commodity prices in general before production hotspots pushed up oil prices late in the week. Treasury yields drifted lower aided by flows out of the equity markets pushing rates to levels not seen since mid-April. For the week the DJIA lost 0.2%, the S&P lost 0.4% and the NASDAQ fell 0.8%.

The April US non-farm payrolls missed expectations, dropping to +160K from the revised +208K figure in March. Unemployment held steady at 5%, while there was a slight uptick in wages. The NFP figure echoed the softness seen in the ADP report out earlier in the week. On Tuesday, Mark Zandi wrote that that "the job market appears to have stumbled in April. Job growth noticeably slowed, with some weakness across most sectors." Analysts suggested the data would greatly lower the chances of a Fed rate hike in June. After the data Fed funds futures repriced for only a 6% chance of a rate increase in June, while odds of a July move were at 24%. Traders now see the first rate increase coming in December.

Fed officials had plenty to say after last week's soft Q1 GDP reading, although these comments arrived before the weaker payrolls data. San Francisco Fed President Williams discounted the data, citing similar seasonal patterns in recent years, and asserted it was the GDP data that was out of sync with the rest of the data. The Atlanta Fed's Lockhart expressed concern that the lackluster GDP data could "turn out, in fact, to be persistent." While there will be relatively little Q2 growth data on hand by the June meeting, Lockhart said the probability of a rate move was higher than markets were pricing in. Fed hawk Bullard said there's a pretty big gap between market expectations of rate path and Fed's prior projections, and reiterated June is a "live" meeting for rates, though he was still undecided on the issue. Dallas Fed President Kaplan wants firmer GDP before advocating for another rate, but anticipates another rate hike this summer if the data keeps steady.

Chinese data out this week was a mixed bag. The official manufacturing and services PMIs fell slightly in April from March levels, but both remained in expansion territory - barely. The small- and medium-sized company focused Caixin manufacturing and services PMIs also declined in April m/m, with the factory index in contraction for the 14th straight month. Interestingly, prices paid saw good upticks across the board, rising at the highest pace in years. With deflationary effects abating, the outlook continues to improve for commodities demand, but on the whole economists with Commerzbank said the data reflects Beijing's campaign of "managed stabilization." Caixin wrote that the reports indicated the economy lacks a solid foundation for recovery and is still in the process of bottoming out. In the wake of the data, former PBoC advisor Yu Yongding called for the government to implement more fiscal stimulus to avoid an economic hard landing.

The Reserve Bank of Australia moved to head off fears of deflation and reduced the official cash rate for the first time since last May, cutting 25 bps to a historic low of 1.75%. Last week, the Q1 report showed q/q CPI dropping into negative territory for the first time in seven years, while the key core CPI measure fell to 1.5%, the lowest level on record and well below the RBA's target band of 2-3%. The RBA warned that labor indicators have turned more mixed (after a run of stronger prints earlier this year) and that economic growth has become more moderate. Later in the week, the RBA's quarterly policy statement deepened inflation worries by cutting the end 2016 CPI target to +1-2% from +2-3% prior and the end-2017 target to +1.5-2.5%. The move strongly suggests the central bank is leaving the window open for more easing. The aussie had been rebounding strongly over the last two months with the general uptick in commodity prices, however the RBA cut decisively reversed the trend. AUD/USD topped out two weeks ago around 0.7835 and has tumbled to 0.7350 as of Friday.

Crude prices pulled back a bit this week under fire from the weaker global economic data. After nearly taking out $47 last Friday, front-month WTI kept testing back down to $44 and did not manage to close out the week above $45. Brent retreated back to around $45 as well. Squabbling between Saudi Arabia and Iran over production quotas boded ill for a revival of the production freeze deal. There were some concerns about supply disruption as wildfires threatened to burn to the ground the Canadian city of Fort McMurray, at the heart of the country's oil sands region. In Libya, a stand-off between eastern and western political factions prevented some oil cargos from being loaded. However, they did not help crude mark fresh recovery highs.

In Europe, there were reports that the ECB would be comfortable to remain in wait-and-see mode for the next several months. Sources said there was little desire at the ECB to take any more action before September as the bank gauged the effects of negative rates. Meanwhile there were political developments in peripheral states. Spain's King Felipe VI dissolved parliament and scheduled new elections on June 26th, ending months of political deadlock caused by inconclusive elections last December. Polls suggest Spaniards might be in for more of the same after the elections. Greece and its creditors continued talks all week about additional contingency measures needed to help hit its budget surplus targets and unlock further bailout payments. Athens agreed to vote on pension reforms this coming Sunday allowing for a Eurogroup meeting to convene on Monday. Greece has several big debt repayments due in the coming months, most critically in July when it faces a €2.3B repayment to the ECB.

The week in politics was highlighted by Donald Trump clinching the Republican nomination with a convincing win in Indiana, which was seen as the last possible firewall for the 'stop-Trump' movement. His has two rivals immediately dropped out, clearing the field for a confrontation with Hillary Clinton. In the UK, voters choose Sadiq Kahn to fill the high profile post of London mayor, which will make him the city's first Muslim mayor. The win for the Labour Party candidate is also a slap in the face of PM Cameron just a year after his Conservative party won the Parliamentary election by a landslide and as the PM has failed to influence the too-close-to-call polling for the Brexit referendum in June.

As the earnings season rolled through its peak week, pharma giant Pfizer saw modest gains after raising its FY view, while Merck was down on another quarter of revenue contraction. AmerisourceBergen sank 11% on the week after it cut its FY guidance and warned that deflation in the generics space was undermining its pricing power. Media names Time Warner and CBS saw good revenue growth, but only CBS sustained durable gains while TWX was in the red on the week. Kellogg dropped on further revenue contraction and stiff FX headwinds. Valero sank as lower gasoline prices squashed margins and profits missed expectations. Tesla moved its target for achieving a 500K unit annual production volume by two years, to 2018, citing the overwhelming demand for is upcoming Model 3, but the stock tumbled as investors worried about the automaker's growing capital needs.

Another megadeal was thrown into the dustbin of history this week as Halliburton's plan to merge with Baker Hughes finally collapsed under the weight of antitrust opposition. The companies cancelled their $28 billion deal on Sunday after more than a year trying to get approval in the US, the EU, Brazil and Australia. Regulators were not convinced the remedies proposed by Halliburton would prevent the reduction of choice in oilfield services, ultimately running a risk of higher energy prices. Shares of HAL have risen 40% and BHI has gained 12% in the three months to the deal cancellation as the prospects of closing the acquisition looked worse and worse. Note that there was plenty of talk that BHI remains a takeover target now that Halliburton is out of the way. In other merger news, Quintiles and IMS Health agreed to a merger of equals. The two health care information and technology providers would combine to create a firm worth $17.6 billion based on market capitalization and with $7.2 billion in pro forma revenue.

>>> US CLose Dow+0.45% S&P+0.32% Nasdaq+0.40% Russell+9.61%

Closing Market Summary: Stocks End Down Week Higher After Jobs Report

The stock market ended a downbeat week on a higher note as investors digested a below-consensus reading of the Employment Situation Report. The S&P 500 gained 0.3%, trimming its weekly loss to 0.4%. Additional factors that impacted today's trade included a rebound in oil, an upswing in the dollar, and leadership from the heavily-weighted industrial (+0.7%), technology (+0.7%), and consumer discretionary (+0.7%) sectors. The Dow Jones Industrial Average (+0.5%) finished ahead of the Nasdaq Composite (+0.4%) and the benchmark index (+0.3%).

Today's session began on a lower note as investors digested the newly released Employment Situation Report for April. The headline nonfarm payrolls reading (160K, consensus 207K) came in below consensus while average hourly earnings ticked higher by 0.3% (consensus +0.3%). The report painted a conflicting picture of employment and simultaneously added to the recent string of weaker-than-expected economic data.

Furthermore, the employment data clouded investors' perception of the path of the feds funds rate. On one hand, the report showed softening in the labor market, and on the other, the report bumped the year-over-year increase in average hourly earnings to 2.5%. The fed funds futures market dropped the probability of a rate hike at the June meeting down to 6.0% before bidding it back to the previous day's probability of 13.1% by the end of the session.

The major averages ticked off their session lows in the late morning as a rebound in oil helped rally the broader market. For its part, WTI crude ended its day higher by 0.6% at $44.59/bbl. Equities extended their rally through the afternoon as heavily-weighted industrials (+0.7%), technology (+0.7%), and consumer discretionary (+0.7%) climbed the leaderboard.

By the end of the session, seven sectors were above their flat lines as materials (+0.9%), industrials (+0.7%), technology (+0.7%), and consumer discretionary (+0.7%) led. On the flipside, utilities (-0.7%), health care (-0.6%), and energy (-0.2%) rounded out the leaderboard.

The industrial sector (+0.7%) demonstrated relative strength as the Dow Jones Transportation Averages (+0.9%) trimmed its weekly decline to 1.7%. In the group, logistics companies outperformed with Expeditors International (EXPD 48.40, +0.93) and C.H. Robinson (CHRW 72.82, +1.97) gaining 2.0% and 2.8%, respectively.

In the technology sector (+0.7%), Cognizant Technology (CTSH 60.55, +2.96) gained 5.1% reporting above-consensus bottom-line results for the first quarter. Elsewhere, large cap names Facebook (FB 119.49, +1.68) and Alphabet (GOOG 711.12) gained 1.4% apiece while Apple (AAPL 92.72, -0.52) continued to see pressure. The name declined 1.1% on a weekly basis.

The heavyweight consumer discretionary sector (+0.7%) outperformed as Amazon (AMZN 673.95, +14.86) erased an early loss to finish its day higher by 2.3%. The broader sector ended its week with a gain of 0.1%, trailing only utilities (-0.7%; week-to-date +0.8%) and consumer staples (+0.5%; week-to-date +1.7%) over that period.

On the flipside, health care (-0.6%) underperformed throughout the day as biotechnology weighed. Additionally, generic drug names underperformed after Endo International (ENDP 16.17, -10.42) lowered its full-year guidance below consensus.

The U.S. Dollar Index (93.82, +0.04) rebounded throughout the day as the greenback made up ground against the euro and the yen. The euro/dollar pair finished flat at 1.1405 while the dollar lost 0.2% against the yen (107.10).

The Treasury complex ended its day on a lower note with the yield on the 10-yr note dropping three basis points to 1.78%. This compares to last Friday's settlement at 1.83%.

Today's participation was above average as more than 945 million shares changed hands on the NYSE floor.

  • Nasdaq Composite -5.4% YTD
  • Russell 2000 -2.0% YTD
  • S&P 500 +0.7% YTD 
  • Dow Jones +1.8% YTD