Markets rally in December but Hedge Funds didn't capture all the gains

The year 2016 ended on a strong note for US equities. As investors warmed to the upcoming change of guard in D.C. and the Fed pulled the trigger on an expected rate hike, December saw markets rally and the Dow inched closer to 20,000. The S&P 500 moved up by 2% as Value significantly outperformed Growth on the month (2.5% and 1.3% for R1K Value and R1K Growth, respectively). Some of the IWM momentum from last month carried into December as small caps continued to outpace larger capitalization securities.

Hedge Fund long equities did not manage to capture all the market gains (despite a small-cap overweight that helped) as the HFU returned just 1.1% for the month trailing the markets by 90bps. Sector weightings, security selection, as well as dispersion shifts all played a role in the underperformance. While the trend of high intra-sector dispersion continued, intra-stock dispersion reverted sharply. Financials and Real Estate sectors rewarded Hedge Funds on the right side of the “Trump Trade.” Three of our top five performing managers for the month (based on simulated performance) were Financials specialists.

Dispersion of Stocks in the Russell 3000: Avg. Top Half Minus Avg. Bottom Half

However, some big winners in the defensive Telecom sector (which rose sharply) were passed over. For example, AT&T and Verizon, which both rallied, were largely missed by hedge funds. Though widely held amongst managers, the two stocks are relatively small positions, well underweight the market, on average. There were many examples of similar misses across other sectors. In general, HFs are underweight Telecom and Financials and overweight Consumer Discretionary. That positioning hurt from an allocation perspective in December.

On a positive note, our HF factors, Concentration and Crowdedness, staged an impressive comeback. Rebounding from a dismal 2015, the most crowded stocks in hedge funds closed the year +16.5%, easily besting our three other indices (not to mention the market). The most concentrated stocks, or those with highest percentage of shares held by hedge funds, returned a solid 5% in December driven by CVR Energy and Clovis Oncology, two long-time hedge fund darlings.

Visit our Monthly State of the Industry report to see all of last month’s most relevant data, including the top alpha-contributing stocks for December and the top hedge funds based off of simulated returns. Alpha users can click through the report to view all stats in real time.