Identifying Hedge Fund Crowding
This piece follows the approach of our earlier articles on fund crowding: We created a position-weighted portfolio (HF Aggregate) consisting of popular long U.S. equity holdings of all hedge funds with medium to low turnover that are tractable from quarterly position filings. We then analyzed HF Aggregate’s risk relative to U.S. Market (Russell 3000) using AlphaBetaWorks’ Statistical Equity Risk Model to identify sources of crowding. More background information and explanations of the terms used below are available in those earlier articles.Hedge Fund Aggregate’s Risk
The Q4 2014 HF Aggregate had 3.0% estimated future annual tracking error relative to U.S. Market. Risk was primarily due to factor (systematic) bets: The components of HF Aggregate’s relative risk on 12/31/2014 were the following:Source |
Volatility (%) |
Share of Variance (%) |
Factor |
2.23 |
56.32 |
Residual |
1.96 |
43.68 |
Total |
2.97 |
100.00 |
Hedge Fund Factor (Systematic) Crowding
Below are HF Aggregate’s principal factor exposures (in red) relative to U.S. Market’s (in gray) as of 12/31/2014: Of these bets, Market (Beta) and Oil are responsible for over 80% of the factor risk relative to U.S. Market. These are the main components of the 2.23% Factor Volatility in the first table: HF Aggregate has become more systematically crowded since Q3 2014. The following factors were the top contributors to the relative systematic risk on 12/31/2014:Factor |
Relative Exposure (%) |
Portfoio Variance (%²) |
Share of Systematic Variance (%) |
Market |
13.26 |
3.10 |
62.37 |
Oil Price |
2.23 |
1.01 |
20.32 |
Finance |
-7.49 |
0.43 |
8.65 |
Industrial |
9.53 |
0.35 |
7.04 |
Utilities |
-3.36 |
0.26 |
5.23 |
Other Factors | -0.18 |
-3.62 |
|
Total | 4.97 |
100.00 |
Hedge Fund Residual (Idiosyncratic) Crowding
Turning to HF Aggregate’s residual variance relative to U.S. Market, eight stocks were responsible for over half of the relative residual risk: These stocks will be the primary drivers of HF Aggregate’s and of the most crowded firms’ returns. They will also be affected by the vagaries of capital flows into and out of hedge funds. Investors should be ready for seemingly inexplicable volatility in these names. They may be wonderful individual investments, but history is not on their side, since crowded bets have historically underperformed. The list is mostly unchanged from the previous quarter:Symbol |
Name |
Exposure (%) |
Share of Idiosyncratic Variance (%) |
LNG |
Cheniere Energy, Inc. |
1.70 |
15.73 |
AGN |
Allergan, Inc. |
3.53 |
9.51 |
VRX |
Valeant Pharmaceuticals International, Inc. |
2.35 |
9.18 |
CHTR |
Charter Communications, Inc. Class A |
1.80 |
3.88 |
HTZ |
Hertz Global Holdings, Inc. |
1.37 |
3.35 |
EBAY |
eBay Inc. |
1.91 |
3.27 |
MU |
Micron Technology, Inc. |
1.08 |
3.21 |
BIDU |
Baidu, Inc. Sponsored ADR Class A |
1.22 |
3.14 |
PCLN |
Priceline Group Inc |
1.29 |
2.43 |
SUNE |
SunEdison, Inc. |
0.63 |
2.29 |
- There is both factor (systematic/market) and residual (idiosyncratic/security-specific) crowding of hedge funds’ long U.S. equity portfolios.
- Hedge funds have become more systematically crowded during Q4 2014, primarily by increasing their Beta.
- The main sources of idiosyncratic crowding are: LNG, AGN, VRX, CHTR, HTZ, EBAY, and MU.
- The crowded hedge fund portfolio has historically underperformed its passive alternative. Investors would have made more by taking the same risk passively – hedge fund investors should pay close attention to crowding before allocating capital.