Hedge funds employing long/short strategies have seen significant gains in 2024 due to an economic environment that has disproportionately affected heavily shorted stocks, according to a recent report by UBS.
Reversal of Fortunes
In the last two months of 2023, shares in heavily shorted companies actually outperformed their counterparts, leading to diminished returns for hedge funds utilizing long/short strategies. However, there has been a notable shift since the beginning of this year, with stocks of highly-shorted companies faring worse than their less-shorted peers across various sectors and sizes.
A Boon for Hedge Funds
This reversal of fortune has provided a much-needed boost for hedge funds employing long/short strategies in 2024. By underperforming relative to their competitors, heavily shorted stocks have rewarded the bets placed by short sellers.
‘Hedge Fund Nirvana’
Analysts at UBS have coined the term 'Hedge Fund Nirvana' to describe the current economic landscape. This reference to the concept of paradise in Buddhist philosophy highlights the escape from cyclic suffering, or Saṃsāra, experienced by hedge funds in previous cycles.
Shorted Stocks: A Shift in Performance
Introduction
According to a recent report by UBS, heavily shorted companies have been underperforming compared to less shorted companies. This has led to a favorable shift in the performance of long/short hedge funds. The shift can be attributed to optimistic forecasts about sharper and faster interest rate cuts, coupled with a macroeconomic environment that supports the process of long/short managers.
Performance Comparison
The UBS report highlights several heavily shorted companies that have seen a decrease in performance. Marathon Oil (MRO) (-1.10%), Bath & Body Works (BBWI) (+0.79%), Best Buy (BBY) (+0.15%), Blackstone (BX) (-0.13%), Whirlpool (WHR) (-1.03%), Kroger (KR) (-0.07%), and Moderna (MRNA) (-6.67%) have all struggled compared to their less shorted counterparts.
In contrast, less shorted stocks have shown better performance. Alphabet (GOOGL) (+2.12%), Amazon.com (AMZN) (+2.71%), Kinder Morgan (KMI) (-0.12%), American Express (AXP) (+0.60%), Eli Lilly (LLY) (+0.61%), General Electric (GE) (+0.17%), and Salesforce (CRM) (-0.22%) have outperformed their peers.
Macroeconomic Factors
The shift in performance coincides with more optimistic forecasts about potential interest rate cuts. As a result, the macroeconomic environment has become more favorable for long/short managers. The UBS report suggests that regardless of their efforts to mitigate macro risk, long/short managers are influenced by the conducive or less conducive nature of the environment they operate in.
Conclusion
The year-to-date underperformance of heavily shorted stocks compared to less shorted stocks presents a favorable backdrop for hedge funds. As long as economic reports continue to demonstrate strength, this performance trend is likely to persist. The shift provides an opportunity for long/short hedge funds to capitalize on market conditions and generate positive returns.
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