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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.

Source: Small Caps Stand to Gain when Hedge Funds Jump Back In