World Economy

Hedge Fund Losses Worst Quarter in 6 Years

Hedge Fund Losses Worst Quarter in 6 YearsHedge Fund Losses Worst Quarter in 6 Years

One of the most popular hedge fund trades just hit a wall. An investment approach that profits from the divergent paths of high- and low- momentum stocks over time, a strategy that had one of its biggest gains on record in 2015, seized up in the last three months, posting the worst quarter in six years. The plunge helped zap returns among a big category of quantitative hedge funds, the so-called market neutral group, whose year-to-date decline of 2.3% is the largest since 2012.

While the tactic may be esoteric, the force that pummeled it is not: a growing revulsion among investors to shares whose main claim to fame in the past few years was that they kept going up. Anyone pursuing the strategy got into particular trouble shorting companies with the lowest price momentum, a section of the market that ended up being the quarter’s biggest winner, Bloomberg reported.

Anacor Pharmaceuticals Inc., whose 250% rally in 2015 made it one of the biggest momentum darlings, has plunged 53% year-to-date. Activision Blizzard Inc., up 92% in 2015, saw valuations peak at the highest in almost six years high on Dec. 31. Shares have since tumbled 13%, the video game-maker’s worst quarterly performance since June 2010.

At the same time, bets against low-momentum stocks backfired at an almost unprecedented rate, with shorted shares advancing 11% in March for its best monthly return since 2011. Harley Davidson Inc., the eighth most-shorted stock in the measure at the start of the year, posted a 13% gain over the three months. Range Resource Corp., the third most shorted, had its best quarter in over a decade.

The extent of the wreckage depends on which measure you use. A Dow Jones index tracking the 200 highest-momentum stocks while betting against the 200 lowest dropped 8.1% in the first three months of 2016, the most since 2009. By JPMorgan & Chase Co.’s account, momentum long-short fell 20% this year through mid-March, a rupture comparable to the “quant meltdown” of August 2007, when the unwinding of crowded trades clobbered equity hedge funds and seeped into the broader market.

Less open to debate is the strategy’s popularity—a herding effect that some analysts say doomed it to blow up. Hedge funds increased their exposure to momentum stocks in every quarter of 2015, making it the second most popular style after expected growth, data compiled by Evercore ISI show.

On the long leg of the trade, valuations had become stretched. The Dow Jones Long Momentum index P/E ratio was 27.2 heading into the new year, 16% above the four-year average. Likewise, investors became weary of expensive shares after the selloff this year, causing momentum stocks to miss out on the S&P 500’s 6.6% March rally, said Abhra Banerji, the director of quantitative research at Evercore ISI. Price momentum shares fell 4.3% over the same period, according to a portfolio compiled by the banking advisory firm.