Hedge funds so far are lagging the market this year. If that situation persists, this will be the seventh consecutive year the supposed smart-money set fails to beat the widely followed indexes.
Goldman Sachs seems to think it knows what is causing the underperformance: Hedge funds are not taking enough risk.
The Wall Street bank found that hedge funds “tend to own stocks unlikely to generate alpha,” after analyzing the quarterly stock holdings contained in the recent first-quarter 13F reports. Many of them are crowding into the same stocks.
“Hedge funds can boost performance by shifting their research attention to high [return] dispersion stocks,” Goldman says in a new report.
So, while investors and analysts regularly peruse quarterly 13F filings for the stocks most widely held by hedge funds in the belief that the smartest investors have the greatest conviction about these stocks, Goldman says the funds can best beat their peers by emphasizing what the firm deems to be unowned stocks that are most likely to trade with high idiosyncratic risk.
In the report, Goldman identifies 22 stocks contained in the Russell 1000 whose market capitalizations exceed $5 billion and “rank among the top 10 percent of alpha-generation opportunities,” according to the firm’s model.
To make this list, the stock must have less than 5 percent of its market cap owned by hedge funds and rank as a top ten portfolio position for no more than five of the 685 fundamentally driven hedge funds that Goldman uses to construct its Hedge Fund VIP list, which we have highlighted several times in the past.
Also, these 22 stocks have less than 10 percent of their shares held short.
“The list highlights both long and short opportunities for hedge funds and other stock-pickers,” Goldman states. “Rather than identify a directional view, our framework simply identifies the stocks most likely to generate alpha by trading independently, based on company-specific factors.”
Here are the 22 stocks:
