While most regular investors don’t have millions left to invest in hedge funds, they can still learn from their playbook. Especially as the economy appears to be heading into recession, a closer look at where hedge funds see opportunities (as well as which stocks and sectors they’re betting on) can provide interesting information for retail investors.
On Thursday, Jefferies Equity Research released a report detailing some of the recent moves by hedge funds over the past few months, based on data covering trillions in assets. The big insight? Growth is back in fashion — but not among the traditionally popular tech stocks. After switching into cyclicals in June, the funds are reversing their direction from last month, going back to an overweight in secular growth and an underweight in cyclicals.
Long-term growth — stocks of innovative companies that tend to post consistent earnings — moved from a 5.9% net underweight to a 9.3% overweight, which fell back to levels analysts watched last January. Overall, the funds increased exposure to healthcare while reducing exposure to industrials, financials, communications services, materials and information technology. Because secular growth stocks tend to grow despite economic conditions, they’re good picks during a recession. “Sector weightings have changed quite dramatically in my opinion,” says equity strategist Steven DeSanctis. He explained that many funds look back at what has worked historically during times of economic downturns. “[Investors] wanting to own secular growth stocks during an economic recession because that’s what worked in 2020…I think people immediately went back to stocks they know and have owned in the past.”
But Big Tech didn’t get much encouragement this past quarter. Hedge funds have trimmed their weight in leading technology stocks, which Jefferies calls the “Sweet 16” in the report, after increasing weights in those stocks over the past four months. Hedge funds have reduced their weightings in the four largest stocks: Google, Meta, Amazon and Microsoft by more than 1%. The Sweet 16’s underweight versus the S&P 500 is now 11.4% versus 4.5% a month ago, its lowest weight since October 2020.
After taking a net short position in healthcare in April, the sector is now attracting the attention of hedge funds. Health care is now overweight at 16.1% compared to the S&P 500 index at 14.4%. A month ago, healthcare was 5.3% net short. Over 30% of the names that switched from short to long came from the healthcare group. DeSanctis explained that the bullish outlook on healthcare was motivated by positive data and the notion that stocks could bounce back after a lackluster recent performance. “I think finally you reach maximum pain. So the shorts are off, having just decided enough is enough,” he said. “We’ve seen some positive data, including deals and mergers, which also contributed.”
Energy is now the largest underweight – down 6.4% – and the group’s only net short position in hedge funds. They are net short by 1.6%. “They’ve traditionally been net lack of energy, they ended up going net long, and now they’re net short again,” DeSanctis said. “Oil and energy typically don’t hold up in an economic recession.”
Jefferies saw just three changes to its “crowded” portfolio, which consists of stocks popular with both the long-only and hedge fund groups. The names added were Thermo Fisher Scientific with a NET Length Weight of 1.4, Linde plc with a NET Length Weight of 0.8 and Coca-Cola Company, also with a NET Length Weight of 0.8.
A caveat for investors: Of the 6 portfolios Jeffries tracks, only 2 outperformed the S&P 500 in July. The report acknowledges that overall fund performance has been disappointing given current market conditions.
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