Author Archives: Scalper1

The Costs Of Hedge Fund Crowding In Q3 2015

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 ( α 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. αReturn 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: 7/31/2015 8/31/2015 9/30/2015 Total Other Consumer Services -101.16 -113.93 -312.84 -426.77 Oil and Gas Pipelines 472.21 -465.63 -10.29 -475.93 Specialty Chemicals -155.87 196.41 -730.73 -534.32 Oil Refining and Marketing 262.69 -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 Click to enlarge Historical Return from Security Selection of Hedge Fund Specialty Chemicals Sector Aggregate Hedge Fund Specialty Chemicals Crowding Click to enlarge Crowded Hedge Fund Specialty Chemicals Sector Bets The following table contains detailed data on these crowded holdings: Exposure (%) Net Exposure Share of Risk (%) HF Sector Aggr. Sector Aggr. % $mil Days of Trading (NYSE: PAH ) Platform Specialty Products Corp. 17.59 2.52 15.07 1,351.8 14.3 44.62 (NYSE: APD ) Air Products and Chemicals, Inc. 47.46 13.89 33.57 3,010.8 13.7 22.09 (NYSE: LYB ) LyondellBasell Industries NV 3.36 23.03 -19.67 -1,764.2 -5.9 14.04 (NASDAQ: GRBK ) Green Brick Partners, Inc. 2.99 0.25 2.74 245.7 79.7 10.58 (NYSE: GRA ) W. R. Grace & Co. 11.76 3.45 8.32 745.8 11.0 2.99 (NYSE: PX ) Praxair, Inc. 0.31 16.29 -15.98 -1,433.5 -5.9 2.21 (NYSE: AXLL ) Axiall Corporation 2.79 1.20 1.59 142.8 4.5 0.74 (NYSE: TROX ) Tronox Ltd. 1.80 0.45 1.35 121.2 14.2 0.36 (NYSE: ARG ) Airgas, Inc. 0.19 3.77 -3.59 -321.8 -4.1 0.33 (NASDAQ: SIAL ) Sigma-Aldrich Corporation 3.32 7.88 -4.56 -408.6 -2.3 0.28 (NYSE: NEU ) NewMarket Corporation 0.23 2.61 -2.38 -213.4 -6.0 0.26 (NYSE: VHI ) Valhi, Inc. 0.02 0.91 -0.88 -79.2 -240.2 0.26 (NYSE: CYT ) Cytec Industries Inc. 0.07 2.04 -1.97 -176.5 -2.0 0.18 (NYSE: ASH ) Ashland Inc. 1.66 3.89 -2.23 -200.0 -2.4 0.18 (NYSE: POL ) PolyOne Corporation 0.19 1.65 -1.46 -131.2 -4.3 0.10 (NASDAQ: TANH ) Tantech Holdings Ltd. 0.00 0.19 -0.19 -17.3 -2.7 0.09 (NASDAQ: BCPC ) Balchem Corporation 0.00 0.82 -0.82 -73.4 -8.8 0.07 (NYSE: CBM ) Cambrex Corporation 0.06 0.65 -0.59 -53.2 -2.1 0.06 (NYSE: CMP ) Compass Minerals International, Inc. 0.15 1.31 -1.16 -104.0 -4.8 0.06 … Other Positions 0.29 0.51 Total 100.00 Oil Refining and Marketing – Hedge Fund Alpha and Crowding Hedge Fund Oil Refining and Marketing Security Selection Performance Click to enlarge Historical Return from Security Selection of Hedge Fund Oil Refining and Marketing Sector Aggregate Hedge Fund Oil Refining and Marketing Crowding Click to enlarge Crowded Hedge Fund Oil Refining and Marketing Sector Bets The following table contains detailed data on these crowded holdings: Exposure (%) Net Exposure Share of Risk (%) HF Sector Aggr. Sector Aggr. % $mil Days of Trading (NYSE: MWE ) MarkWest Energy Partners, L.P. 18.23 5.31 12.92 848.9 6.1 31.86 (NYSE: VLO ) Valero Energy Corporation 0.38 16.06 -15.68 -1,030.4 -2.7 23.34 (NYSE: TSO ) Tesoro Corporation 14.32 5.36 8.96 589.0 1.4 12.74 (NYSE: TRGP ) Targa Resources Corp. 8.99 2.52 6.47 425.3 8.7 7.76 (NYSE: PSX ) Phillips 66 9.21 21.86 -12.66 -831.8 -2.8 6.03 (NYSE: PBF ) PBF Energy, Inc. Class A 6.80 1.23 5.56 365.6 7.8 5.84 (NYSE: NGLS ) Targa Resources Partners LP 8.74 3.52 5.21 342.7 6.2 2.84 (NYSE: WGP ) Western Gas Equity Partners LP 3.58 6.63 -3.05 -200.5 -7.4 2.06 (NYSE: MPC ) Marathon Petroleum Corporation 9.59 14.34 -4.75 -312.0 -1.1 1.81 (NYSE: TLLP ) Tesoro Logistics LP 5.12 2.33 2.79 183.1 3.5 1.45 (NYSE: HFC ) HollyFrontier Corporation 1.29 4.22 -2.93 -192.3 -1.4 1.11 (NYSE: WNR ) Western Refining, Inc. 0.21 2.10 -1.89 -124.5 -1.4 0.61 (NYSE: IOC ) Interoil Corporation 0.66 1.50 -0.84 -55.3 -6.9 0.49 (NYSE: GEL ) Genesis Energy, L.P. 4.35 2.20 2.15 141.1 6.2 0.34 (NYSE: ENBL ) Enable Midstream Partners LP 0.39 1.73 -1.34 -88.2 -31.6 0.33 (NYSE: EMES ) Emerge Energy Services LP 0.01 0.43 -0.42 -27.6 -6.1 0.29 (NYSE: DK ) Delek US Holdings, Inc. 0.00 1.07 -1.07 -70.0 -1.2 0.26 (NYSE: WNRL ) Western Refining Logistics, LP 1.57 0.36 1.21 79.5 15.0 0.24 (NYSE: ALJ ) Alon USA Energy, Inc. 0.00 0.67 -0.67 -44.1 -2.3 0.18 (NYSE: NS ) NuStar Energy L.P. 3.50 2.33 1.17 76.9 1.4 0.15 … Other Positions 0.07 0.28 Total Semiconductors – Hedge Fund Alpha and Crowding Hedge Fund Semiconductor Security Selection Performance Click to enlarge Historical Return from Security Selection of Hedge Fund Semiconductors Sector Aggregate 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 Click to enlarge Crowded Hedge Fund Semiconductors Sector Bets The following table contains detailed data on these crowded holdings: Exposure (%) Net Exposure Share of Risk (%) HF Sector Aggr. Sector Aggr. % $mil Days of Trading (NYSE: SUNE ) SunEdison, Inc. 33.18 1.82 31.36 2,550.9 9.6 86.72 (NASDAQ: MU ) Micron Technology, Inc. 18.87 3.95 14.93 1,214.1 2.9 8.85 (NASDAQ: INTC ) Intel Corporation 3.72 27.94 -24.22 -1,970.2 -1.6 2.01 (NASDAQ: SEMI ) SunEdison Semiconductor, Inc. 3.22 0.14 3.08 250.7 52.5 0.38 (NASDAQ: SWKS ) Skyworks Solutions, Inc. 0.04 3.85 -3.82 -310.4 -0.9 0.38 (NASDAQ: TXN ) Texas Instruments Incorporated 0.09 10.38 -10.28 -836.6 -1.9 0.32 (NASDAQ: NXPI ) NXP Semiconductors NV 7.90 4.41 3.49 283.6 1.0 0.29 (NASDAQ: AVGO ) Avago Technologies Limited 3.29 6.69 -3.40 -276.3 -0.5 0.18 (NYSE: FSL ) Freescale Semiconductor Inc 0.02 2.40 -2.38 -193.5 -5.2 0.17 (NASDAQ: ON ) ON Semiconductor Corporation 3.39 0.97 2.42 196.6 4.3 0.08 (NASDAQ: MLNX ) Mellanox Technologies, Ltd. 1.89 0.43 1.45 118.3 0.7 0.08 (NASDAQ: BRCM ) Broadcom Corporation Class A 7.81 5.51 2.30 187.2 0.5 0.07 (NYSE: MX ) MagnaChip Semiconductor Corporation 0.92 0.05 0.87 70.9 31.2 0.07 (NASDAQ: ADI ) Analog Devices, Inc. 0.05 3.90 -3.85 -312.9 -1.7 0.06 (NASDAQ: QRVO ) Qorvo, Inc. 1.13 2.32 -1.19 -96.7 -1.1 0.06 (NASDAQ: NVDA ) NVIDIA Corporation 0.58 2.10 -1.51 -123.1 -0.4 0.04 (0Q19) CEVA, Inc. 1.25 0.08 1.17 95.5 30.7 0.04 (NASDAQ: MRVL ) Marvell Technology Group Ltd. 0.04 1.32 -1.28 -104.4 -0.9 0.03 (NASDAQ: MXIM ) Maxim Integrated Products, Inc. 0.34 1.90 -1.56 -126.9 -1.7 0.02 (NYSE: MXL ) MaxLinear, Inc. Class A 0.74 0.12 0.62 50.6 2.8 0.02 … Other Positions 0.36 0.13 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. Fund followers and 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. Copyright © 2012-2016, AlphaBetaWorks, a division of Alpha Beta Analytics, LLC. All rights reserved. Content may not be republished without express written consent.

ETF Update: 4 New Launches And 2 Closures

Welcome back to the SA ETF Update. My goal is to keep Seeking Alpha readers up to date on the ETF universe and to gain some visibility, both for the ETF community, and for me as its editor (so users know who to approach with issues, article ideas, to become a contributor, etc.) Every weekend, or every other weekend (depending on the reader response and submission volumes), we will highlight fund launches and closures for the week, as well as any news items that could impact ETF investors. So far January has not been the best month for buy and hold investing. As a long term investor I know stock dips are really opportunities to buy into strong companies that will not just recover but bloom again. However, even having studied behavioral portfolio management, I still get that flight response that all investors will feel at some time. As you can see in the fund flows YTD tables below, I am not the only person feeling this way. Top Redemptions Fund Name Net Flows in USD Millions SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) -4,073.29 iShares Russell 2000 ETF (NYSEARCA: IWM ) -2,108.65 PowerShares QQQ Trust ETF (NASDAQ: QQQ ) -1,996.87 iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) -1,648.93 iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ) -1,349.74 Data Source: ETF.com Top Creations Fund Name Net Flows in USD Millions iShares Short Treasury Bond ETF (NYSEARCA: SHV ) -4,073.29 Vanguard S&P 500 ETF (NYSEARCA: VOO ) -2,108.65 iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) -1,996.87 iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) -1,648.93 iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) -1,349.74 Data Source: ETF.com Inflows and outflows can be a great reflection of what investors and money managers actually think is happening in the markets. As I don’t offer investment advice, and none of my articles should be seen as advice, I will leave it to readers to decide what these data points mean in the comments section below. However, I do want to point out that most of the top new creations are Treasury ETFs, while the redemptions are funds tracking the popular U.S. equity indices. It is up to you to decide how (or if) this information from 3 weeks of market activity will affect your portfolio strategy. Even with the churning markets there were 4 new funds launched in the last 2 weeks, so let’s jump in: Fund launches for the week of January 11th, 2015 Van Eck launches the first generic pharmaceuticals ETF (1/13): The Market Vectors Generic Drugs ETF (NASDAQ: GNRX ) focuses on companies that make the majority of their revenues from generic medication. While there are other pharmaceutical ETFs avaliable to investors, the largest being the Dynamic Pharmaceuticals ETF (NYSEARCA: PJP ), GNRX is the first funds to highlight companies focused on the generic medication market. The fund currently holds 84 companies and the top holdings feature names biotech investors are likely already familiar with; Allergan Plc (NYSE: AGN ) (8.69%), Teva Pharmaceutical (NYSE: TEVA ) (8.60%) and Baxalta Inc (NYSE: BXLT ) (5.83%). Reality Shares launches 2 more DIVCON ETFs (1/14): Last week saw the launch of the Reality Shares DIVCON Leaders Dividend ETF (BATS: LEAD ) and the company already has two more out of the gate. However, the Reality Shares DIVCON Dividend Defender ETF (BATS: DFND ) and the Reality Shares DIVCON Dividend Guardian ETF (BATS: GARD ) are both long/short portfolios, which is new for the firm. As a refresher, the DIVCON methodology “rates companies’ dividend health based on seven weighted factors our research shows are correlated with dividend growth.” According to each ETFs homepage, DFND seeks to provide long-term capital appreciation through the use of a hedged equity portfolio, while GARD provides exposure to large-cap U.S. companies with the highest probability of increasing their dividends, as measured by their DIVCON Scores. However, GARD has some twists as well. It dynamically adjusts its market exposure based on the firm’s Guard Indicator market strength gauge, making it a much more complex fund. State Street (NYSE: STT ) rolls out its innovation ETF (1/14): The SPDR FactSet Innovative Technology ETF (NYSEARCA: XITK ) tracks an index of companies selected by FactSet meant to represent the most innovative segments of the technology and electronic media industries. As described on the fund homepage, “the Index Provider considers the most innovative segments of the Technology sector and Electronic Media sub-sector to be those with the highest revenue growth and believes that these companies are often involved in cutting edge research, innovative product and service development, disruptive business models, or a combination of these activities.” Top holdings include Rovi Corporation (NASDAQ: ROVI ) (2.22%), Super Micro Computer Inc. (NASDAQ: SMCI ) (1.49%) and CyberArk Software Ltd. (NASDAQ: CYBR ) (1.42%). There were no fund launches for the week of January 18th, 2015 There were no fund closures for the week of January 11th, 2015 Fund closures for the week of January 18th, 2015 ETRACS 2xMonthly Leveraged S&P MLP Index ETN (NYSEARCA: MLPV ) UBS ETRACS 2x Leveraged Long Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPL ) Have any other questions on ETFs or ETNs? Please comment below and I will try to clear things up. As an author and editor I have found that constructive feedback is the best way to grow. What you would like to see discussed in the future? How can I improve this series to meet reader needs? Please share your thoughts on this first edition of the ETF Update series in the comments section below. Have a view on something that’s coming up or a new fund? Submit an article.

Asset Allocation For 2016

Key views: 1-3 months: short Gold long DAX long XLY / short XLP 6-12 months: short XAUUSD short XLE / long SPX long GBPJPY 12+ months: short R2K / long SPX short AUDNZD In spite of the ugly start of the year, I do not think there have been fundamental changes in the global markets since a year ago. A regime shift actually occurred in 2014-2015. By that time, the global economy had managed to stage a mostly uninterrupted, albeit very slow, recovery. In 2014, it became clear that the global market cycle was entering its late stage. At that time, risk asset valuations had reached “fair value” levels across the asset classes, following 5 years of a fairly re-rating on the back of extremely accommodative monetary policy globally. The Fed then made it clear that monetary policy would gradually tighten and the markets priced this in rapidly, mostly by bidding up the US dollar and selling short dated treasuries. Due to the still deeply embedded remains of the “forward guidance”, the market moves were big, prompting volatility to return to more normal levels not seen in years. At the same time, the US economy began showing signs of mid-cycle dynamics, with the unemployment rate sharply falling closer towards most estimates of NAIRU, consumer confidence rising to cyclical highs and M&A activity surging. The environment in which most of today’s prime-aged investment professionals built their careers is characterized by “irrational exuberance”, with stock market valuations typically ballooning during the bull markets and deflating rapidly during recessions. Many got burned in the process and I do not think that the industry will get ahead of itself once again. It is more likely that valuations would remain at fundamentally justified levels (rather than trending up persistently), with the stock market only collapsing in case of catastrophic outcomes. In addition to the US financial and economic cycles, a few other cycles are important for understanding the current regime. The commodity cycle is still in its downtrend. I do not think anyone is good enough at forecasting spot prices of commodities based on supply and demand fundamentals. The safest strategy is to look at where the trend is and stick to it until it reverses. This is how CTAs have been making money for decades trading commodities and I feel no need to reinvent the wheel. The commodity price decline is fundamentally related to a number of other developments: a continued evolution of the global economy from manufacturing to services, the weakening demand from China, the fracking revolution and more recently the rise of the US dollar. All these interrelated trends are putting an immense amount of pressure on emerging economies. While emerging market currencies have fallen substantially, a more decisive shift from the old growth model will be required in order to adjust to the evolving world. There will inevitably be both winners and losers in this game. Equivalently, the developed market economies are experiencing a similar challenge, with manufacturing and extraction showing signs of continued weakness, and tight financial conditions depressing US corporate earnings. Going forward, I anticipate a continuation of the desynchronized market patterns across the world and return of volatility to normal levels. My hunch is that strategists and fund managers in the industry generally seem to be experiencing quite low levels of conviction in their views. There is also a healthy amount of bears in the market, which should lead to a better balance, despite higher volatility. In such an environment, relative value trades will be a much more important source of return generation compared to simple exposure to broad markets. Quantitative indicators for “alpha potential” from bottom-up stock picking have still not normalized (even though it has improved), so I expect that single stock selection will still struggle in 2016. However, big picture long/short macro positions should work well at the time when most investors continue to fret over whether we are in a bull or a bear market. In 2016, cross-asset performance will be driven by a small number of key risks. The most important ones: US Monetary policy, Chinese economic slowdown and the commodity price collapse. I will be writing about these, as well as about my key trades, in the following weeks, so stay tuned.