Small Caps Stand to Gain when Hedge Funds Jump Back In

To understand which segments of the U.S. equity market were most affected by hedge fund selling pressures late in 2008, a good place to look is 13F filings with the SEC. These are required from institutional investment managers with US$100 million or more in securities.

Citigroup’s small and mid cap stock strategist, Lori Calvasina, reviewed recently released filings for the fourth quarter and found that small and mid cap stocks were hit hardest.

From the second quarter of 2008 to the fourth quarter, hedge fund ownership fell from 12.5% to 9.7% for the average Russell 2000 stock. While there was a decline from 12.3% to 9.9% for the average mid cap stock in the index, large caps saw a much smaller dip – from 7.5% to 6.1%.

“Hedge funds are now slightly more entrenched in mid caps than small caps and remain more deeply positioned in both segments than large cap,” Ms. Calvasina said in a research note. “This highlights risks but also opportunities for small/mid caps, as smaller caps will likely benefit more than large caps when hedge funds put cash back to work.”

On a sector-by-sector basis, consumer discretionary stocks saw the greatest decline in hedge fund ownership in the second half of 2008 for small caps, while technology led the way in selling for mid caps. While these sectors were underperforming as the November market lows approached, they have been outperforming in recent weeks.

“Tech’s case seems to be built on balance sheets and cash cushions, but discretionary outperformance is not as easy to explain beyond the tendency to outperform late in recessions,” Ms. Calvasina said.

Meanwhile, hedge fund long positions in small caps declined less for energy than any other sector in the second half of 2008, except financials and utilities. The analyst noted that hedge funds do not usually carry high exposure to these two sectors.

Comments

[bc818:]

I prefer VB to IWM. VB has a higher dividend and lower rexpense ratio; however, IWM has much more volume. There performance is nearly identical.

Feb 24 03:28 PM

[ladders11:]

What about VBR? Small cap value has a better return over the last 100 years. I'm not sure about the methodology: price to book and *forward* p/e ratio? Does this make sense?

Similar charts anyhow.

Feb 24 04:50 PM

[Nick Waddell:]

Small caps can be more aversely affected than large caps because of liquidity issues. We have found our client, Serenic Corp (TSXV:SER) has been affected by this, it has wild price swings because there a very few shares outstanding and the lack of liquidity to small caps exaggerates these movements.

I think this is a major reason small caps lead the way out of recessions; relative to other stocks, their prices are distorted. They become more fairly priced when liquidity returns.

Disclosure: I own SER.

Feb 24 04:55 PM

[Mad Hedge F...:]

This is a great time to buy small cap stocks in any equity market, including Japan. This sector was one of the worst hit in the recent melt down, but historically it outperforms by a large margin in the first 12 months after the end of a recession. Once their survival is no longer in doubt, these often debt dependent stocks rocket on any improvement in the economic trend. This is the only time I ever hire outside managers, because I haven’t the patience, the manpower, or the expertise to scour over the balance sheets and earnings statements of hundreds of obscure little niche companies. I have always been a big cap player because I have always dealt with investors who had to get $100 million to work in the market in a hurry, an impossibility in the small cap arena. In the U.S., buy the iShares Russell 2000 Index ETF (IWM). For the Japan play, buy the closed end Atlantis Japan Growth Fund (LSE-AJG) traded in London, managed by my old friend Ed Merner, at $8.05, a bargain basement 27% discount to its NAV of $11.04, if you are lucky enough to find shares to buy.

Feb 24 05:16 PM

[wise:]

There is only a small cap effect in North America, you will perform worse long-term in smaller companies elsewhere

Feb 24 10:47 PM