Hedge funds played a key role in the success of small and mid-cap stocks in 2009. But the shine may be wearing off, says new research from Citigroup Capital Markets.
"While hedge fund ownership stakes for small and mid have essentially been flat since 4Q08, they have been inching up in large," said Lori Calvasina, Citigroup's small and mid-cap equity strategist, in a note to clients.
"In other words, the gap in hedge fund ownership levels between small and mid relative to large has been shrinking."
Based on her research, hedge funds held a long position stake in the average small cap stock of 6.4% in the fourth quarter of 2009. The stake in the average mid cap stock was 5.8% and 2.8% for the average large cap stock.
"We found that in 2009 there were three sectors that saw a pick up in average hedge fund ownership stakes within large cap, but a decline or flattening out of
hedge fund ownership stakes in small and mid.
"These were Consumer Discretionary, Health Care, Technology, which collectively account for about 46% of the market cap weight in the Russell 2000, 37% of the market cap weight in the Russell Mid Cap index, and 44% of the market cap weight in the Russell Top 200,"
For the financials sector, average hedge fund ownership stakes rose in all three market capitalization levels, with large cap stakes hitting their highest level since the first quarter of 2005.
Meanwhile, the average hedge ownership levels were flat in 2009 for large cap Materials, and fell for small and mid cap Materials. Ownership stakes in energy stocks were unchanged across the market cap spectrum.
Ms. Calvasina said the shift in market cap preferences by hedge funds reflects the next stage in the recovery trade.
She expects less volatility for small and mid cap stocks and more volatility for large caps over the coming months. At the same time, she is worried that hedge funds, now less interested in smaller cap stocks, will have an overall negative implication for the small cap segment of the equity market.
"The implications for mid caps are less clear to us, and we wonder if bigger mid caps (which tend to drive the performance of the mid cap performance indices which are market cap weighted) may ultimately benefit from the shift away from smaller names," she wrote.