Flickr/Arturo J. Paniagua
To profit from the stock market, be sure to follow the “smart
money.” Just figure out where hedge funds are investing, and
then do the same.
It’s a strategy that, if executed properly, would’ve worked this
year as the stocks most widely held by hedge funds have
outperformed the broader market.
Luckily for any aspiring smart money tracker, Goldman Sachs
maintains an index of stocks in which fundamentally-driven hedge
funds hold large positions — in other words, the companies
that matter most to speculative institutional investors.
The Goldman Hedge Fund VIP basket has climbed about 10% this
year, beating the S&P 500 by almost four percentage
points. Boasting the likes of Facebook, Amazon, Alphabet and
Apple among the most popular and heavily-weighted holdings, the
index has been a big beneficiary of a stock market that’s been
rewarding investors for doubling down on proven winners.
The willingness of hedge funds to continue buying the same
strong-performing stocks has pushed the firms’ long exposure
to the highest since 2013, according to Goldman. Further, gross
leverage — or the total asset value held either long or short by
a fund — has surged to the highest since the financial crisis.
Upon first glance, this type of momentum-based investing may seem
like a recipe for disaster. After all, crowded positions
typically unwind in swift and unforgiving fashion, suggesting
considerable downside risk in the event of an unexpected market
shock. That’s what happened in early 2016, when high-flying
mega-cap tech stocks led to a temporary selloff.
Not so fast, says Goldman, which points out that high leverage
alone has not historically challenged momentum. Rather, there
were other external conditions that led to the 2016 weakness that
are absent today, most notably earnings.
Mired in a five-quarter profit contraction back then,
corporations in the S&P 500 are now coming off their
best earnings growth since 2011. Goldman also notes that crowding
in hedge funds is less pronounced now than it was a year