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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.

Gundlach: Buy Closed-End Bond Funds And Mortgage REITs

It seems that bond king Jeffrey Gundlach and I are reading from the same playbook. In the Barron’s Roundtable (registration required), he made his case for deeply-discounted closed-end bond funds and mortgage REITs. I’ve been bullish on both for over a year… and I’ve taken my lumps for it. But the values are there, and I’m collecting outsized payouts while I wait. Some of Gundlach’s comments are worth passing on: A portion of the credit market has a safety cushion large enough to absorb another 200- or 300-basis-point widening in junk-bond spreads versus Treasuries. I’m referring to closed-end bond funds, which trade on the New York Stock Exchange. Closed-ends are one of the best plays on the Fed not raising interest rates… Closed-end funds are leveraged, and investors have been afraid to own them because they fear that the Fed has launched a tightening cycle. Also, based on daily data going back 20 years, they have traded at a 2% discount, on average, to net asset value. Recently, however, the sector traded at a 10% to 12% discount to NAV. It has traded at such a steep discount only 5% of the time. In the past 20 years, the discount has been wider than that only during the financial crisis in 2008-’09… If history is any guide, discounts would widen further only in a 2008-type scenario, which is possible, although doubtful so soon after the prior crisis. Under current circumstances, you have about two percentage points of downside, and 10 points of upside to return to the historical discount. That makes a basket of closed-ends attractive. If you bought a junk-bond-oriented closed-end trading at a 12% discount to NAV, some of the bonds would be trading at a 15% discount. This isn’t a bad idea, but I prefer Brookfield Total Return (HTR). It is trading just as poorly as some other closed-ends, but is vastly safer. Gundlach’s firm, DoubleLine, is far too big to buy closed-end funds in any meaningful size. He’d end up single-handedly moving the market. But for individual investors, these may be the best option available these days. As Gundlach puts it, “If the S&P rises 10%, closed-ends could return 20%. If the stock market falls 30%, a decline is already priced into these funds. I look at closed-end funds as a good place to put your risk money.” I agree. Given the yawning discounts among closed-end bond funds, we have that all-important margin of safety in this space. Moving on, Gundlach had some interesting things to say about mortgage REITs: Fears that the Fed will raise rates significantly are overblown. This brings me to Annaly Capital Management (NYSE: NLY ), one of the largest mortgage REITs [real-estate investment trust]. It has an $8 billion market cap and has been trading at a 25% discount to book value for some time… It is selling for $9.41. A few years back, it sold for $18. These sorts of stocks have step-function moves. They don’t move by a few percent; they go from $18 to $12 and from $12 to $9, and if the yield curve is inverted, and they have to cut their dividends, things get really bad. But a discount of 30% to book value is the widest ever for Annaly, and historically very wide for a mortgage REIT. Annaly is paying a dividend of 30 cents per quarter. It yields 12.75%. The environment for Annaly has improved… At today’s discount, a lot of bad things are priced in. If the Fed doesn’t raise interest rates much, the stock should go higher. I’m not currently long Annaly. Rather than bet on a single mortgage REIT, I opted to buy a broader basket via an ETF. But my rationale was much the same. Across the sector, you have quality names trading at enormous discounts to their underlying portfolio values. The sector is worth more dead than alive. The rationale move here would be for mortgage REITs to plow the proceeds from maturing and prepaid mortgage securities into buying back their own stock. An m-REIT yielding 10% and trading at 80 cents on the dollar is going to deliver a better return than the mortgage securities they’re currently buying. Annaly, for one, has done exactly that, announcing over the summer that they intended to buy back about $1 billion in shares . At today’s prices, that amounts to about 12% of Annaly’s market cap. Expect more of their peers to follow suit. Disclaimer : This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post