I worked at Thomson Reuters for 16-1/2 years, where I sat next to a colleague responsible for tracking hedge funds and reporting on their behavior. Over time, he noticed a shift in the investing behavior of hedge funds. While they showed little correlation in the early 1990s, by the second decade of the 21st century, they had become increasingly alike. This change was attributed to the proliferation of hedge fund conferences, where they shared their “best ideas,” as well as the popularity of computer algorithms and momentum strategies. These factors displaced the former tendencies towards value investing and identifying bargains.
Although there are exceptions, such as money managed by Seth Klarman, Marc Faber, Jim Rogers, Howard Marks, Ray Dalio, and others, the majority of hedge funds now crowd into identical concepts at any given time. This herd following is particularly prevalent at key extremes and likely contributes to the exaggeration of these extremes. Notably, hedge funds tend to do the opposite of top corporate insiders and commercials. Therefore, tracking insider behavior and traders’ commitments can be a profitable strategy. In the 21st century, the most consistently successful approach has been to follow insiders and commercials at rare extremes while going against hedge funds.
Recent examples of this behavior include hedge funds establishing a record short position in U.S. Treasuries in October 2023. This was followed by a significant rally in Treasuries, as hedge funds rushed to close their shorts. Hedge funds also crowded into AI stocks, while top corporate insiders sold their shares. Despite the overall bear market, funds concentrated in popular megacaps within the AI bubble have outperformed.
Hedge funds have also demonstrated overcrowding in other areas, such as palladium, gold, and silver. These crowded trades often lead to reversals, making them ripe for potential busts. Additionally, hedge funds have been involved in shorting the Japanese yen and overcrowding into energy commodities.
The media often encourage retail investors to follow hedge funds, as they receive information and interpretation from them. However, following the media can result in buying near market tops and selling near bottoms. Currently, the U.S. equity bear market is following its usual sequence of sector bottoms, with U.S. Treasuries likely already reaching their lowest point. Gold and silver mining shares are expected to bottom in spring 2024, followed by emerging market stocks and bonds in summer 2024. Non-precious commodity producers and special situations will likely bottom later in 2024.
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