Applying a robust risk model to hedge fund holdings data helps avoid losses and yields profitable opportunities. In this article, we highlight the sectors with the largest Hedge Fund losses due to crowding in Q3 2015, which sum to $4 billion. Our methodology provides an early-warning system for losses in crowded names. This analysis also identifies crowded stocks beaten up by hedge fund liquidations, which tend to mean-revert.

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 (αReturn, 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

Hedge Fund Specialty Chemicals Crowding

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
GB:PAH	Platform Specialty Products Corp.	17.59	2.52	15.07	1,351.8	14.3	44.62
APD	Air Products and Chemicals, Inc.	47.46	13.89	33.57	3,010.8	13.7	22.09
LYB	LyondellBasell Industries NV	3.36	23.03	-19.67	-1,764.2	-5.9	14.04
GRBK	Green Brick Partners, Inc.	2.99	0.25	2.74	245.7	79.7	10.58
GRA	W. R. Grace \& Co.	11.76	3.45	8.32	745.8	11.0	2.99
PX	Praxair, Inc.	0.31	16.29	-15.98	-1,433.5	-5.9	2.21
AXLL	Axiall Corporation	2.79	1.20	1.59	142.8	4.5	0.74
TROX	Tronox Ltd.	1.80	0.45	1.35	121.2	14.2	0.36
ARG	Airgas, Inc.	0.19	3.77	-3.59	-321.8	-4.1	0.33
SIAL	Sigma-Aldrich Corporation	3.32	7.88	-4.56	-408.6	-2.3	0.28
NEU	NewMarket Corporation	0.23	2.61	-2.38	-213.4	-6.0	0.26
VHI	Valhi, Inc.	0.02	0.91	-0.88	-79.2	-240.2	0.26
CYT	Cytec Industries Inc.	0.07	2.04	-1.97	-176.5	-2.0	0.18
ASH	Ashland Inc.	1.66	3.89	-2.23	-200.0	-2.4	0.18
POL	PolyOne Corporation	0.19	1.65	-1.46	-131.2	-4.3	0.10
TANH	Tantech Holdings Ltd.	0.00	0.19	-0.19	-17.3	-2.7	0.09
BCPC	Balchem Corporation	0.00	0.82	-0.82	-73.4	-8.8	0.07
CBM	Cambrex Corporation	0.06	0.65	-0.59	-53.2	-2.1	0.06
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

Hedge Fund Oil Refining and Marketing Crowding

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
MWE	MarkWest Energy Partners, L.P.	18.23	5.31	12.92	848.9	6.1	31.86
VLO	Valero Energy Corporation	0.38	16.06	-15.68	-1,030.4	-2.7	23.34
TSO	Tesoro Corporation	14.32	5.36	8.96	589.0	1.4	12.74
TRGP	Targa Resources Corp.	8.99	2.52	6.47	425.3	8.7	7.76
PSX	Phillips 66	9.21	21.86	-12.66	-831.8	-2.8	6.03
PBF	PBF Energy, Inc. Class A	6.80	1.23	5.56	365.6	7.8	5.84
NGLS	Targa Resources Partners LP	8.74	3.52	5.21	342.7	6.2	2.84
WGP	Western Gas Equity Partners LP	3.58	6.63	-3.05	-200.5	-7.4	2.06
MPC	Marathon Petroleum Corporation	9.59	14.34	-4.75	-312.0	-1.1	1.81
TLLP	Tesoro Logistics LP	5.12	2.33	2.79	183.1	3.5	1.45
HFC	HollyFrontier Corporation	1.29	4.22	-2.93	-192.3	-1.4	1.11
WNR	Western Refining, Inc.	0.21	2.10	-1.89	-124.5	-1.4	0.61
IOC	Interoil Corporation	0.66	1.50	-0.84	-55.3	-6.9	0.49
GEL	Genesis Energy, L.P.	4.35	2.20	2.15	141.1	6.2	0.34
ENBL	Enable Midstream Partners LP	0.39	1.73	-1.34	-88.2	-31.6	0.33
EMES	Emerge Energy Services LP	0.01	0.43	-0.42	-27.6	-6.1	0.29
DK	Delek US Holdings, Inc.	0.00	1.07	-1.07	-70.0	-1.2	0.26
WNRL	Western Refining Logistics, LP	1.57	0.36	1.21	79.5	15.0	0.24
ALJ	Alon USA Energy, Inc.	0.00	0.67	-0.67	-44.1	-2.3	0.18
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

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

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
SUNE	SunEdison, Inc.	33.18	1.82	31.36	2,550.9	9.6	86.72
MU	Micron Technology, Inc.	18.87	3.95	14.93	1,214.1	2.9	8.85
INTC	Intel Corporation	3.72	27.94	-24.22	-1,970.2	-1.6	2.01
SEMI	SunEdison Semiconductor, Inc.	3.22	0.14	3.08	250.7	52.5	0.38
SWKS	Skyworks Solutions, Inc.	0.04	3.85	-3.82	-310.4	-0.9	0.38
TXN	Texas Instruments Incorporated	0.09	10.38	-10.28	-836.6	-1.9	0.32
NXPI	NXP Semiconductors NV	7.90	4.41	3.49	283.6	1.0	0.29
AVGO	Avago Technologies Limited	3.29	6.69	-3.40	-276.3	-0.5	0.18
FSL	Freescale Semiconductor Inc	0.02	2.40	-2.38	-193.5	-5.2	0.17
ON	ON Semiconductor Corporation	3.39	0.97	2.42	196.6	4.3	0.08
MLNX	Mellanox Technologies, Ltd.	1.89	0.43	1.45	118.3	0.7	0.08
BRCM	Broadcom Corporation Class A	7.81	5.51	2.30	187.2	0.5	0.07
MX	MagnaChip Semiconductor Corporation	0.92	0.05	0.87	70.9	31.2	0.07
ADI	Analog Devices, Inc.	0.05	3.90	-3.85	-312.9	-1.7	0.06
QRVO	Qorvo, Inc.	1.13	2.32	-1.19	-96.7	-1.1	0.06
NVDA	NVIDIA Corporation	0.58	2.10	-1.51	-123.1	-0.4	0.04
GB:0Q19	CEVA, Inc.	1.25	0.08	1.17	95.5	30.7	0.04
MRVL	Marvell Technology Group Ltd.	0.04	1.32	-1.28	-104.4	-0.9	0.03
MXIM	Maxim Integrated Products, Inc.	0.34	1.90	-1.56	-126.9	-1.7	0.02
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.
• 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.
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