Goldman Report Reveals Hedge Funds’ 50 "VIP" Stocks

Hedge funds are supposed to do one thing really well: hedging. That means they should be able to successfully take opposing long and short positions, and enhance and protect their returns under any market conditions. And with today’s challenging investing environment, it feels like prime time to see how they’re doing. I did a deep dive into Goldman Sachs’s latest report on hedge fund activity. Here are my takeaways…

1. Hedge funds’ top stock picks have already done better than the S&P 500 this year.

Goldman’s hedge fund report analyzed 758 hedge funds with $2.3 trillion of stock investments between them – that’s $1.5 trillion in long bets and $727 billion in short ones. The “Hedge Fund VIP List”, the 50 stocks that appear most frequently among hedge funds’ top holdings, delivered a punchy 10% gain in just the first six weeks of this year versus the S&P 500’s 6%.

What’s more, in 2022, hedge funds declined only 4%, while the S&P 500 dropped 18%.

However, so far this year, hedge funds that trade based on global macro trends came in flat, with the market becoming more micro-driven – that is, steered by company-specific factors.

Year-to-date returns of various assets. Sources: HFR, FactSet, and Goldman Sachs Global Investment Research.

2. Hedge funds’ most popular stock picks are fairly tech-heavy.

Now let’s check out which specific stocks these hedge funds have been picking. Microsoft is No. 1 on that Hedge Fund Vip List, narrowly beating e-commerce giant Amazon. Facebook parent Meta takes the bronze medal, having fallen out of the top five last quarter for the first time since 2014. Google parent Alphabet is fourth and Visa is fifth.

Netflix and Uber lost the top-five status this time around, and Tesla dropped from the VIP list entirely. We also saw 12 newcomers joining the elite top-50 club (bolded in the chart below).

Hedge Fund VIP List of 50 stocks that appear most frequently among Hedge Fund top 10 stock holdings. Sources: Solactive, FactSet, and Goldman Sachs Global Investment Research.

This VIP list has outperformed the S&P 500 in 59% of quarters since 2001 with an average quarterly excess return of 0.38 percentage points. But here’s the thing: in 2021 and 2022, the basket underperformed the S&P 500 by 30 percentage points. So it’s not a fail-safe, but it does still provide decent insight into where the “smart money” might be socking money away. The VIP list also doesn’t contain any stocks within the consumer staples, materials, and real estate sectors. With all the high-flying tech stocks sitting near the top of the list, it’s not surprising that information technology holds the heaviest weight overall at 32%.

3. Hedge funds have increased their risk.

Let me introduce you to the “net leverage” metric: this is the difference between the amount hedge funds are spending on long and short bets. The higher the net leverage, the more risk they’re taking on. The metric has rebounded from its 2022 lows, which themselves were levels not seen since 2019. And that tells us that these funds are taking on more risk. The net leverage metric isn’t where it was a few years ago, but this rebound has been impressive.

Goldman’s data shows that it’s at the 24th percentile when measured against the past five years, and the 30th against the past year. If the net leverage continues to move upward, it’ll be a sign that hedge funds like what they’re seeing in the markets and are willing to take on more risk.

Gross and net leverage exposure of hedge funds since 2016. Sources: Goldman Sachs Prime Services and Goldman Sachs Global Investment Research.

4. Hedge funds have changed up their strategies and their sector weightings.

Hedge funds this year have done well by turning their back on “momentum strategies” – that’s when you generally trade alongside the markets’ sustained price trend. Instead, they entered 2023 with the most anti-momentum bias in their portfolios on record – breaking from the pack.

Goldman’s got a long/short momentum factor that it uses to measure this kind of move, and it dropped this year by 20%. That’s one of the most significant declines since 1980. The bank says a move of this size has typically been characteristic of a recession or a crisis, having been seen during the 1990s tech bubble and the crash of 1987.

Luckily for hedge funds, they’ve been favoring more growth stocks in their portfolios and shunning value ones, which were the poster child for momentum stocks over the past two years.

Around the start of this year, hedge funds changed up their sector allocations. In January, the tech sector represented 20.9% net exposure, but this was still significantly underweight, compared to the Russell 3000, which was at 24.2%. Healthcare came in second place, eating up 19.9% of funds’ net exposure, but it had the biggest overweight relative to the Russell 3000, which was at 15%.

Since the previous quarter, hedge funds shifted toward info tech, communication services, and consumer discretionary (the biggest, with a 3.27 percentage point change), and shifted away from energy, industrials, and materials. In fact, the energy weighting is the lightest it’s been since late 2007 and saw the biggest chop from the previous quarter.

Sector changes from the fourth quarter of 2022, compared to now, and returns so far this year. Here, “bp” stands for basis point, and 100 basis points equals one percentage point. Sources: FactSet and Goldman Sachs Global Investment Research.

What’s the opportunity then?

You have two main options: take it for granted that hedge funds are, ahem, on the money, and bet alongside them, or use this data to make opposite, contrarian bets. If you’re in the first camp, you could buy the Goldman Sachs Hedge Industry VIP ETF (ticker: GVIP; expense ratio: 0.45%). It tracks the VIP list of 50 stocks, so it’s an easy way to mirror what the funds are doing. Or you could pick individual stocks from the list above, and DIY your very own VIP list.

If you’d prefer to invest by sector, the iShares S&P 500 Consumer Discretionary Sector UCITS ETF (IUCD; 0.15%) and the iShares S&P 500 Communication Sector UCITS ETF (IUCM; 0.15%) could come in handy. But if you want to take the contrarian tack, simply short these assets instead via your broker.