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For Hedge Funds, The Real Pain Is Only Just Starting

In the aftermath of the August hedge fund slaughter in which the most widely held by "smart money" stocks got pummeled leading to the marquee hedge fund names reporting their worst month in years, and leading others - such as us - to once again mock the concept of "hedging" (only a handful of funds actually were hedged against "black Monday" such as Mark Spitznagel, who had a billion dollar payday on August 24 and who has since warned that if investors thought August was scary "They Ain't Seen Nothin' Yet"), the consensus opinion was that the pain for the hedge fund "Hotel California" is over, and that the worst of the pain is behind us.

Once again consensus is dead wrong.

Presenting Exhibit A: Goldman's latest YTD performance breakdown by strategy basket.

It reveals is that far from suffering even the most modest correction, the "Hedge Fund Hotel" strategy (aka the most concentrated holdings), is massively outperforming not only the broader market, but has returned double the second most profitable strategy - investing in companies with high revenue growth.


Exhibit B: for all the talk that names with high hedge fund concentration have been crushed, the reality is far different as the "smartest money" realizes that once the selling of the "hotel" names begins, it is every billionaire for himself.


Intuitively this makes sense: being some of the most ration market participants, the hedge funds who are among the holders of the most widely held stocks, realize that a strategy of selling the most concentrated names, will promptly waterfall into an all out liquidation of the benchmark market names (such as the FANGs and Apples) that have kept the S&P from a bear market YTD, even as the average stock is now approaching at 20% correction. As such nobody wants to "defect" from a game theoretical equilibrium in which nobody wants to be the first to sell, as nobody knows how profound the resulting tumble would be.

However, now that the Fed crushed its own confidence by not hiking by even a meager 25 bps, unless the Fed or other central banks step in and buy more E-Minis in the coming days to prop up both the market but general confidence (recall that the best paid hedge funder of the past few years, David "Balls to the Wall" Tepper himself is no longer bullish on stocks, instead predicting a 16x P/E multiple may be generous) the same hedge funds which have diligently kept the secret of the "hedge fund hotel prisoner's dilemma", will just as quickly remember that he who sells first sells best.

In fact, the tipping point of the next bear market will come precisely when the best performing strategy of 2015, buying companies just because other hedge funds bought them, stops working at which point the market will suffer far more dramatic losses than what was observed during the Black Monday week of August, when "only" risk parity strategies got forcibly margined out.

Source: Goldman Sachs US Weekly Kickstart