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by Tyler Durden, Zero Hedge,

Yesterday we highlighted the top 50 stocks that comprise the hedge fund “darling” universe. And while it is good to know which stocks will get the chop first the next time there is a major margin call induced liquidation scare, as David Kostin points out in a follow-up piece there is a much more nuanced read through for Hedge Fund data. “We estimate hedge funds own roughly 3% of the US equity market. Turnover of all hedge fund positions averaged 34% during 3Q 2011 (nearly 140% annualized). The tilt of hedge fund holdings towards large-cap stocks has been increasing for almost 10 years. The typical hedge fund operates 36% net long, down from 2Q 2011. Combining long and short position data, hedge funds have the greatest net portfolio exposure to Consumer Discretionary (23%), Information Technology (20%), and Energy (14%).” he then proceeds to list the 10 conclusions that can be derived using the most recent public 13F data (which is understandable quite stale already in our day and age of sub-24 hour investment horizons). Yet the bulk of conclusions are mostly fluff save for the following: “ The average hedge fund returned -2% YTD in 2011 through November 11th compared with +2% for the S&P 500″, “Hedge fund returns are highly dependent on the performance of a few key stocks” and “The typical hedge fund operates 36% net long ($394 billion net/$822 billion long), versus 46% in 2Q 2011.” So just why do people still pay 2 and 20 to chase popular, concentrated stock positions while underperforming the broader market again?

From Goldman Sachs

Our most recent Hedge Fund Trend Monitor report analyzed 679 hedge funds with $1.1 trillion of gross equity positions consisting of $655 billion of long stock-specific and ETF equity assets and an estimated $417 billion of short single-stock and ETF positions. We have published our Hedge Fund Trend Monitor quarterly for the past five years and analyzed constituent-level portfolio holdings of US hedge funds since 2001. The current report focuses on hedge fund positions at the start of 4Q 2011 and is based on 13-F filings as of November 15, 2011. We list 10 conclusions below:

1. We estimate hedge funds own roughly 3% of the US equity market. For context, US households directly own 33% of the domestic equity market, and indirectly own via mutual funds 21% of the stock market. ETFs account for 4% of the US stock market, slightly more than hedge funds.

2. Turnover of all hedge fund positions averaged 34% during 3Q 2011, representing an annualized rate of nearly 140%. The top quartile of positions (largest holdings) turned over just 20% (80% annualized) while the bottom-quartile of positions (smallest holdings) turned over 47% (188% annualized). Quarterly turnover at the sector-level ranged from a low of 32% in Health Care to a high of 36% in Financials (see
Exhibit 1).

3. The tilt of aggregate hedge fund holdings towards large-cap stocks has been trending higher for almost 10 years. Roughly 45% of the aggregate assets of hedge funds was invested in stocks with equity capitalizations greater than $10 billion as of 3Q 2011, up from 35% in 2002. Just 21% of aggregate assets are invested in small-cap stocks (below $2 billion). The typical hedge fund allocates 33% of its assets to large-cap
stocks ($10+ billion) and 38% to small-cap stocks. The difference between the average and aggregate suggests that the hedge funds with the largest assets under management target large-cap stocks (see Exhibit 2).

4. The typical hedge fund operates 36% net long ($394 billion net/$822 billion long), versus 46% in 2Q 2011. We estimate 20% of short positioning is conducted via ETFs with 15% occurring at the broad index level.

5. Combining long and short position data, hedge funds have the greatest net portfolio exposure to Consumer Discretionary (23.2%), Information Technology (20.2%), and Energy (13.7%). Hedge funds are not benchmarked but relative to the Russell 3000 universe they are 1,088 bp overweight Consumer Discretionary (23.2% vs. 12.3%), and 761 bp underweight Consumer Staples (3.6% vs. 11.2%).

6. The average hedge fund returned -2% YTD in 2011 through November 11th compared with +2% for the S&P 500. The distribution of performance showed that more than 15% of hedge funds returned -10% or worse. However, the S&P 500 has dropped by 8% during the past two weeks. Style matters for hedge fund performance given the average global macro fund returned 4% vs. -5% for the typical equity long/short fund through Nov 11th.

7. The strategy of buying the 20 most concentrated stocks has a strong track record over more than 10 years. We define “concentration” as the share of market capitalization owned in aggregate by hedge funds. Since 2001, the strategy has outperformed the market 69% of the time by an average of 271 bp per quarter (not annualized). The back test suggests that this strategy works in an upward trending market but tends to perform poorly during choppy or flat markets. The “most concentrated” hedge fund ownership basket has underperformed the S&P 500 in 2011 YTD by 62 bp (1.2% vs. 1.8%). See Bloomberg ticker: <GSTHHFHI>. [ZH: we define it as crowding. And like all crowded trades the unwind always is a sight to behold]

8. Hedge fund returns are highly dependent on the performance of a few key stocks. The typical hedge fund has an average of 64% of its long-equity assets invested in its 10 largest positions compared with 31% for the typical large-cap mutual fund, 20% for a small-cap mutual fund, 19% for the S&P 500 and just 2% for the Russell 2000 index (see Exhibit 3).

9. Our Hedge Fund VIP list (Bloomberg ticker: <GSTHHVIP>) contains the 50 stocks that appear most frequently among the top 10 holdings of
fundamentally-driven hedge fund portfolios. The basket of stocks that “matter most” has outperformed the S&P 500 by 60 bp on a quarterly basis since 2001, with a Sharpe Ratio of 0.22. However, the VIP list has lagged the S&P 500 YTD by 347 bp (-1.7% vs. 1.8%). AAPL, GOOG, MSFT, JPM, and PFE rank as the top five stocks in our Hedge Fund VIP list (see Exhibits 4 and 50).

10. Turnover for the VIP basket was below the historical average with 14 new stocks entering the VIP list compared with an average turnover of 17 stocks since 2001. New constituents: ABX, CCI, CHK, CMCSA, DTG, EMC, HES, IBM, NEM, NWSA, OXY, PG, PM, and WMB. From an implementation standpoint, the hedge fund VIP list offers an efficient vehicle for investors seeking to “follow the smart money” based on 13-F filings. The VIP basket has a large cap bias with a median market capitalization of $42 billion compared with $11 billion for the S&P 500. The VIP list contains stocks from nine of the ten sectors (no Utilities).