Hedge Funds Loading Up on Darling Stocks Got a Rude Awakening

(Bloomberg) -- The trend is your friend until it isn’t. That’s a lesson hedge funds learned the hard way during this week’s market turmoil.

Promising news on Covid-19 vaccines set off a violent rotation among stocks Monday and Tuesday that went against professional money managers. As a result, funds that make both bullish and bearish equity bets based on business fundamentals saw their alpha -- the extra return above an equity benchmark -- fall the most since March, according to data compiled by Goldman Sachs Group Inc.’s prime-brokerage unit.

Specifically, market winners and laggards switched positions at the fastest rate on record Monday, as the prospects of vaccines sparked a selloff in the likes of Zoom Video Communications Inc. and Amazon.com Inc., the high-flying stay-at-home stocks. Leading the market were airlines and banks, companies that have been under pressure with Covid-19 cases surging.

The unwind was so swift that the Dow Jones U.S. Thematic Market Neutral Momentum Index plunged a record 16% over Monday and Tuesday. Even though a bounce followed, it’s still down 11% for the week. Zoom Video, a videoconferencing platform, has tumbled 15% this week, trimming its 2020 gain to 529%. Peloton Interactive, a provider of online workouts whose shares have almost quadrupled this year, is poised for its worst weekly decline since July, sinking 14%.

While the shift has since taken a breather, momentum stocks are still trailing the market this week. It marks a rude awakening for anyone who piled into bets that winners will keep winning. In the case of fundamental hedge funds, their exposure to momentum stocks sat at the 98th percentile of a five-year range at the end of last week, Goldman data showed. Over the next two sessions, their alpha fell by 2 percentage points, including the worst erosion in eight months on Monday.

The pain was particularly acute for hedge funds that make bets based on market trends and volatility signals. A slew of investment factors like size and value also reversed at speeds not seen in decades, wrecking havoc on fund returns. By Goldman’s tally, the alpha that these systematic funds had accumulated this year was almost wiped out over Monday and Tuesday.

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