Is the increasing incidence of hedge fund herding a result of the decline in US stock exchange listings? Or stated another way are hedge funds venturing into: foreign equities, forex, commodities and even private equity due to the reduced opportunity set in domestic equities?
Jenny Strasburg and Susan Pulliam at WSJ had a big article up a couple weeks ago discussing the phenomenon of hedge fund herding. They note now hedge funds are seemingly all trading the same stocks in the same fashion. Over the past couple of years there has been a big macroeconomic component in this behavior. However the bottom line is that hedge fund returns look a lot more similar than they ever have. They write:
An analysis of hedge-fund returns by Andrew W. Lo, a Massachusetts Institute of Technology researcher and fund manager, shows that funds have become more likely to lose and gain money together over the past five years. There is a roughly 79% chance any randomly selected pair of hedge funds will move up and down in tandem in a given month from 2006 to 2010, compared with a roughly 67% likelihood from 2001 to 2005, according to his analysis.
Let’s pose an alternative explanation. Aswath Damodaran notes that we see herding behavior in all manner of human activity, not just finance. It is therefore unlikely that hedge funds suddenly became more likely to herd in the past few years. Maybe it was the markets themselves that changed making herding more likely.
How have the US equity markets changed over the past decade? The rise in number, type and assets of exchange traded funds (or ETFs) has made making macro and sector bets easier. However the biggest change may be that the number of listings both on the NYSE and Nasdaq have plummeted over the past decade.
Felix Salmon at Reuters in a recent post has two graphs showing a 32% and 49% decline in listings on the NYSE and Nasdaq since 1999. Here is the Nasdaq graph:
Applying Occam’s Razor could it simply be the case that there are fewer investable stocks out there for hedge funds to pick amongst? Admittedly a number of the stocks that exited in the Nasdaq post-Internet bubble probably should never have been public in the first place. However that opportunity set provided hedge fund investors rich opportunities both on the long and short side over time.
One could argue that the rise in interest in global macro strategies is simply the flip side of this phenomenon. The rising interest in foreign equities, emerging markets, foreign exchange and commodities could simply be the result of mangers looking for additional arenas in which to trade. The financial crisis and its aftermath also played a role in this, but it likely does not explain this shift entirely.
Should we expect this phenomenon to reverse any time soon. Felix Salmon writes:
Inevitably there’s a bare minimum of listings which the US stock market will asymptotically approach. But this isn’t cyclical, it’s secular. We had our big equities boom from 1950 to 2000, and now it’s over. Even if valuations go back up, the cult of the US stock market as the best and obvious place to invest your money has gone forever, in a world where it’s easier, more lucrative, and less risky to buy bonds or foreign stocks or even commodities than it is to buy General Electric or eBay or Enron.
At the moment we do seem to be seeing an increase in interest in initial public offerings. That and the belief that the entire social media industry is poised to enter the public markets provides some relief that this trend towards fewer listings may reverse. On the margin this might make the job of the hedge fund easier, but by no means will it make it easy.
Update: Here is another measure of hedge fund herding (via AlphaClone) based on the percentage of hedge fund filers in the top three positions. It shows a bit of a mixed bag, but