Hedge funds that hunkered down after GameStop are now missing out on market gains

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  • Hedge funds getting burned on their GameStop shorts scrambled to take down overall risk and sell winners to raise cash, posting their largest week of de-leveraging since 2009, according to data from Goldman Sachs.
  • The damage inflicted by the so-called dumb money seems to be lasting. The 20 most popular long positions among hedge funds have lagged the S&P 500 by more than 1% year to date on average, according to RBC.
  • “The impact from January hedge fund degrossing has more than offset the recovery in performance seen from late January through mid February,” said Lori Calvasina, head of U.S. equity strategy at RBC.
  • The January short squeeze also highlighted the risk of the high level of leverage and crowding for hedge funds.

Hedge funds are still licking their wounds after a retail trading frenzy forced the industry to slash its overall exposure to stocks, leading to an underperformance in 2021.

Last month, an army of retail investors who coordinated on social media managed to push GameStop shares up 400% in just one week, creating massive squeezes in a slew of heavily shorted names. Hedge funds getting burned on their short positions scrambled to take down overall risk and sell winners to raise cash.

This kicked off a domino effect that led to hedge funds’ largest week of de-leveraging since February 2009, according to data from Goldman Sachs’ prime brokerage unit.

The dust has yet to settle as the damage inflicted by the so-called dumb money seems to be lasting. The 20 most popular long positions among hedge funds have lagged the S&P 500 by more than 1% year to date on average, according to RBC’s analysis of 330 hedge funds based on the recent regulatory filings.

“It is partly due to hedge fund degrossing in January as hedge funds reacted to the retail trading frenzy that gripped equity markets,” Lori Calvasina, head of U.S. equity strategy at RBC, said in a note. “The impact from January hedge fund degrossing has more than offset the recovery in performance seen from late January through mid February.”

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Meanwhile, amateur retail traders, often scolded for their lack of sophistication compared to Wall Street pros, are building on their momentum even after most of the short squeezes are completed.

A basket of retail favorite stocks has rallied 18% this year, outperforming a basket of the most popular hedge fund long positions by eight percentage points and the S&P 500 by four percentage points, according to Goldman.

This David versus Goliath battle came at a particularly vulnerable time for hedge funds. Professional traders had already gotten caught in a big market rotation out of their tech darlings and into cyclical names amid an economic recovery. Growth-loving hedge funds are still underweight energy and financials, two of the biggest winners this year with a rally of 25% and 10%, respectively.

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