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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.

MLP ETFs Trading At A Huge Discount To NAV

The collapse in oil price has battered the energy sector as a whole, not sparing the master limited partnerships (MLPs) either. In fact, some MLP ETFs have fallen faster than the value of their underlying securities, creating a huge discount to their net asset value or NAV. This suggests an attractive entry point for long-term investors. This is especially true as the authorized participants (NYSE: AP ) of a discounted ETF steps in and redeems the underlying shares to remove the discount and restore the fund’s value back to its NAV. This process results in profits for the ETF holder when the market price rises relative to NAV (read: Is This the Worst Time For MLP ETF Investing? ). MLP: Is A Good Bet Right Now? Trading at deep discounts, the outlook for MLPs is bright amid the oil price rout. This is because most MLPs, which are engaged in the processing and transportation of energy commodities such as natural gas, crude oil, and refined products, are best positioned to withstand the decline in oil prices and be the major beneficiaries of an oil boom in the long term. Acting as toll-takers, these MLPs earn revenues on the volumes flowing through pipes and not on the commodity price. This nature of business will definitely give a boost to these stocks given that worldwide oil production is on the rise. Unlike exploration and production companies whose profits are directly correlated with commodity prices, MLPs have relatively consistent and predictable cash flows, making them safer and less risky than other plays in the broader energy space (read: Oil Hits 12-Year Low: Short Energy Stocks with ETFs ). Beyond the stability, yields are also pretty high thanks to some favorable tax rules – like we see in the REIT space – that push firms in the MLP space to pay out substantially all of their income to investors on a regular basis. Further, MLPs represent a great way of tapping the growing revolutionary developments in the field of unconventional energy. As a result, the steep decline in MLP stocks and ETFs provides an attractive investment opportunity to long-term investors, looking for growth and income. Below, we highlight some products that were trading at a steep discount to NAV as of January 15 (as per Fidelity ): UBS ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPI ) : Discount – 5.32% This product tracks the Alerian MLP Infrastructure Index, which comprises 25 mid-stream energy infrastructure MLPs. It has attracted $1.5 billion in AUM and trades in solid volume of 967,000 shares per day. The note charges 85 bps a year in fees and pays out a hefty yield of 8.04%. Credit Suisse Equal Weight MLP Index ETN (NYSEARCA: MLPN ) : Discount – 5.13% This ETN follows the 30 MLP Index, an equally weighted index that uses a formulaic, proprietary valuation methodology and comprises of 30 midstream MLPs. It has attracted $365.5 million in its assets base so far and sees good average daily volume of more than 325,000 shares. Expense ratio came in at 0.85%. The note pays out 7.53% in annual yield. UBS ETRACS Wells Fargo MLP Index ETN (NYSEARCA: MLPW ) : Discount – 4.69% This note tracks the Wells Fargo Master Limited Partnership Index, which provides exposure to all energy MLPs listed on the New York Stock Exchange or NASDAQ with market cap of at least $200 million. It failed to garner enough investor interest with AUM of just $7 million and sees paltry volume of about 13,000 shares. MLPW charges 85 bps in annual fees and expenses, and pays a solid yield of 9.82%. UBS ETRACS Alerian MLP Index ETN (NYSEARCA: AMU ) : Discount – 4.68% This product tracks the performance of the Alerian MLP Index, which provides exposure to 50 publicly traded energy MLPs. It has amassed $351.4 million in its asset base and trades in solid volume of nearly 468,000 shares. It charges 80 bps in annual fees and sports a dividend yield of 7.16%. RBC Yorkville MLP ETN (NYSEARCA: YGRO ) : Discount – 4.57% This note seeks to offer return of the Yorkville MLP Distribution Growth Leaders Liquid Index, which offers access to 25 MLPs exhibiting the highest distribution growth and superior liquidity profiles. It is also unpopular with AUM of $14.5 million and average daily volume of around 15,000 shares. Expense ratio came in at 0.90% and dividend yield stands at 8.54%. MLP ETNs vs MLP ETFs Unfortunately, there are some tax headaches when using the MLP structure, namely the possible need of a K-1 form at tax time. But this issue can be avoided by looking at MLPs that use an exchange-traded structure. This is because ETNs do not actually hold the securities of an underlying index. Instead, an ETN is an unsubordinated debt security that promises to pay out a return that is equal to an index. This is completely unlike an ETF that buys and sells the securities making up a particular benchmark. Due to this advantage, investors can buy MLP ETNs without the hassle of K-1 at tax time, making the above-products excellent choices for those seeking high yield without the taxation headache. Link to the original post on Zacks.com

Guggenheim Defensive Equity: Another Defensive ETF That Failed Miserably To Do Its Job

As the equities markets are crashing all over the planet, more conservative players look to play defense by considering defensive investments and related exchange traded funds to hedge against the current correction. Defensive Stocks and Sectors During market downturns, high volatility and economic uncertainties, many investors use a risk aversion strategy by rotating to defensive sectors through buying defensive stocks and ETFs to shelter from the storm. Defensive Stocks and Sectors are those deemed non-cyclical and not very dependent on the overall economic cycle. The traditional sectors considered defensive are utilities, consumer staples and healthcare. After all, consumers cannot easily manage without gas and electricity, soap and toothpaste and of course their medicine. Other sectors deemed defensive are the telecom sector and the US real estate REIT sectors. Part of what makes defensive stocks and sectors appealing is their relatively higher and “safer” dividend which caters to investors wanting equity exposure but less risk. DEF Fund Description The Guggenheim Defensive Equity ETF (NYSEARCA: DEF ) seeks investment results that correspond to the performance, before the Fund’s fees and expenses, of the Sabrient Defensive Equity Index (the “Defensive Equity Index”). The Fund invests at least 90% of its total assets in US common stocks, American depositary receipts (“ADRs”) and master limited partnerships (“MLPs”). Guggenheim Funds Investment Advisors, LLC (the “Investment Adviser”) seeks to replicate the performance of the Defensive Equity Index which is comprised of approximately 100 securities selected from a broad universe of global stocks, generally including securities with market capitalizations in excess of $1 billion. For more information about this ETF click here . ETF methodology and Sector Allocation Index selection methodology is designed to identify companies with potentially superior risk/return profiles to outperform during periods of weakness in the markets and/or in the American economy overall. The Index is designed to actively select securities with low relative valuations, conservative accounting, dividend payments and a history of outperformance during bearish market periods. The Index constituents are well-diversified and supposed to represent a “defensive” portfolio. The sector allocation of this ETF is as follows: DEF Dividend and Fees DEF pays a respectable dividend of 3.31% and charges an acceptable management fee of 0.65%. The Perfect Defensive ETF? At first glance, DEF looks like a pretty diversified ETF, positioned within the right sectors to hedge against economic downturns in its focus on traditional defensive stocks, including utilities, real estate and consumer defensive. With its highly regarded investment advisor Guggenheim and an investment strategy that seems logical, DEF might even look like the perfect defensive ETF, as its name suggest, but is it really? Performance of DEF in the past 30 days The following chart depicts the performance of DEF against the S&P 500 index tracked by the SPDR S&P 500 ETF (NYSEARCA: SPY ) during the past 30 days ending Friday January 15, 2016: Click to enlarge As noted on the chart above, DEF utterly failed as a defensive ETF as it tumbled 6.4% when the S&P 500 Index fell 8.4%. Let us compare the performance of DEF against the average performance of the five defensive sectors: Source ycharts.com The failure of DEF is even more evident based on the above table as DEF tumbled by 6.4% against an average decline of 4% for the five main sectors considered to be defensive. So what went wrong with this ETF which seems to tick all the right boxes? In order to understand what went wrong we have to dig a little deeper. Three reasons DEF failed to do its job as a defensive ETF Geographical allocation issues A high 9.3% geographical exposure to the Asian market, of which about one-third relating to emerging markets. The allocations include countries such as Singapore, Taiwan, Japan and Asian emerging markets, all of which are very sensitive to China and took a large hit from the Chinese stock market crash. Stocks in this category include Telekomunik Indonesia (NYSE: TLK ), Japanese Nippon Telegraph & Tele (NYSE: NTT ), and Korean SK Telecom Co (NYSE: SKM ). Direct exposure to China (China Mobile (NYSE: CHL ), China Petroleum & Chemicals (NYSE: SNP ), and Chunghwa Telecom (NYSE: CHT )). About 2% is allocated to South American markets which are highly dependent on commodities and tend to be more sensitive to economic and market volatility and uncertainty. Stocks in this category include Banco De Chile-ADR (NYSE: BCH ) and Mexican Grupo Aeroportuario PAC-ADR (NYSE: PAC ). Sector Allocation issues The Fund has a high 8.2% exposure to the energy sector including oil and gas Master Limited Partnerships. These sectors got hammered the past month. DEF holds indeed high risk stocks for the current environment, such as National Oilwell Varco (NYSE: NOV ) and Targa Resources Partners (NYSE: NGLS ). A 3.2% exposure to the basic material sector which has been diving for the past two years, as commodity prices reached multi-year lows on concerns of a China slowdown. Stocks in the ETF include AGL Resources (NYSE: GAS ) and Syngenta AG (NYSE: SYT ). A very high exposure of 14.5% to the telecom sector proved to be too much for a defensive ETF, as the sector plunged 7.6% to become one of the ugliest defensive plays for the past month. Stocks in the ETF include Verizon (NYSE: VZ ), Frontier Communications (NASDAQ: FTR ), NTT Docomo and Vodafone (NASDAQ: VOD ). Passive Investing Strategy The most notable problem with DEF Fund lays in the fact that it uses a “passive” or “indexing” investment approach which makes it vulnerable as economic conditions change. DEF does not have a dynamic system in place to exclude currently risky sectors which once used to be considered safe, such as the oil sector and commodities sector, or to limit exposure to disfavored regions and countries. Conclusion Guggenheim Defensive Equity DEF – don’t get fooled by its name! The same can be said about other Defensive ETFs which may seem right at first glance. Investors should still do their due diligence and closely examine how the underlying assets are invested before putting money at work. Special note I am currently sharing on Seeking Alpha additions to my high-yield “Retirement Dividend Portfolio” (target yield 6% to 9%), with the latest one: Hedging My High Dividends with German Exposure . Follow me for future updates!