Many hedge funds have long had a torrid love affair with tech stocks. Just as Willie Sutton famously noted that he robbed banks because that’s where the money is, many investors gravitated to tech and Internet stocks because, well, that’s where the growth is, or at least was.
Today there are signs that the long affair with tech stocks might be cooling off. The broad global equity correction has hit highflying stocks such as Apple and Facebook, not to mention a flock of Chinese Internet companies, hard. In fact, signs have existed for much of the year that the bull market was getting shaky, provoking a number of prominent hedge funds to rethink their high concentration of tech stocks.
Over the next five weeks, Institutional Investor will offer a series that examines closely the on-and-off relationship between hedge funds and technology stocks. This is the first of five articles in that series.
Also from this series:
- Hedge Funds and Tech Stocks: A Tighter Focus, a Wider Search
- Hedge Funds and Tech Stocks: Dump the Old, Embrace the New
- Hedge Funds and Tech Stocks: The Allure of Private Investments
- Hedge Funds and Tech Stocks: Tiger Global’s Commitment to Tech
The logic of tech investing is obvious. Whereas most developed economies have grown their gross domestic products at low-single-digit rates (or worse) over the past decade or so, a number of tech companies have seen revenues and even profits explode at double-digit rates or higher, outstripping even fast-growing emerging-markets nations like China. Not surprisingly, investors have been drawn to these magical growth stocks and have been willing to pay higher multiples of earnings for them, further boosting the stock price, on the assumption that the rapid growth would continue.
Most of the hedge funds that stress so-called TMT stocks — tech (including Internet), media and telecom — employ long-short strategies that bet on stocks going up as well as down.
Many of the most aggressive investors in TMT stocks are descendants of legendary hedge fund investor Julian Robertson Jr. of Tiger Management Corp., which closed in 2000. They go by the monickers of Tiger Cubs, Tiger Grandcubs or Tiger Seeds, depending on whether they previously worked at Tiger Management, worked for someone employed there or received capital in return for an ownership stake from Tiger Management. These Tiger progeny include Stephen Mandel Jr.’s Greenwich, Connecticut–based Lone Pine Capital, Charles (Chase) Coleman III’s Tiger Global Management and Philippe Laffont’s Coatue Management, the last two based in New York. One major non-Tiger-related tech intensive fund manager: Daniel Benton’s Rye Brook, New York–based Andor Capital Management.
This tech-centric crowd is best known for making big, concentrated bets on TMT stocks. Many of these managers have demonstrated a knack for investing in the hottest companies in often quickly changing sectors.
Other, more eclectic managers, including shareholder activists, tend to move in and out of tech stocks as part of larger strategies that may also include health care, airline or energy stocks, if a sector’s growth prospects look strong, or even to trade in currency or distressed credit markets.
These hedge funds include major names such as David Tepper’s Appaloosa Management in Short Hills, New Jersey; and Daniel Loeb’s Third Point, David Einhorn’s Greenlight Capital and Eric Mindich’s Eton Park Capital Management, all based in New York.
In recent years, hedge funds have made big bucks on some high-profile tech stocks, including Apple, Facebook, Google, semiconductor maker Micron Technology and Chinese Internet giant Baidu. In the past two years, for example, Apple’s revenues have surged 43 percent and earnings rose 34 percent, while Facebook’s revenues jumped 150 percent and operating earnings swelled nine times. Little wonder that Apple’s stock is up about 60 percent in two years and has tripled over the past three years. Facebook’s stock has more than doubled in the past two years and is up about 150 percent since it went public in 2012.
However, as most investors know painfully well, the faster the rise, the harder the fall. And given the lightning speed with which technology’s winners change, today’s hot stock could be tomorrow’s loser — and the target of short sellers, who bet on a stock’s decline.
This is what has happened to Boise, Idaho–based Micron, well before the markets began their recent retreat. The chipmaker was one of the top performers last year, surging 60 percent. But this year it has declined more than 50 percent, amid downgrades of the stock as investors deem the company’s future growth to be slower than the Wall Street pros had forecast. Moreover, an economic slowdown in China won’t help.
Micron isn’t alone. With tech leading the recent stock market decline, many hedge fund investors are bailing out. At the end of July, hedge fund holdings in information technology (IT) stocks slipped from second to third place, compared with the end of May, according to New York–based Novus. S&P Capital IQ in New York notes that in the second quarter, IT represented the most sold-off sector, with $3.1 billion net value of shares sold, up from $942 million in the first quarter, when it was also the most sold-off sector.
However, further examination suggests that hedge funds may not actually be abandoning TMT stocks as much as it may seem. Novus points out that although hedge funds are still underweight IT compared with the Standard & Poor’s 500 index, if you look at just so-called conviction bets, which it defines as the largest plays of hedge funds, the sector is an overweighted.
Indeed, whereas IT did slip in the rankings, it was superseded by health care, one of the top-performing sectors this year, in the No. 2 spot. Consumer discretionary stocks remained at No. 1.
Hedge fund investors seem to be selectively selling stocks of companies whose growth they perceive as slowing, such as hardware and semiconductor makers, and loading up on the companies they believe will lead the future economy.
“We are entering a sweet spot for selecting individual winners and losers in the equity markets, especially in the TMT and consumer sectors,” points out Paul Hudson, a Tiger Grandcub at Glade Brook Capital Partners, based in Greenwich. “The pace of innovation and widespread adoption of new technologies have never been greater in our careers than it is today. Technology and shifting demographics, including the aging of the baby boom generation and the growing economic importance of the digitally native Millennial generation, are structurally changing consumer and business behavior.”
Many of these stocks are Internet and software companies, some of them privately held, like car service Uber or apartment swap site Airbnb, each founded and based in San Francisco. As a result, a growing number of tech-oriented hedge fund managers are devoting larger portions of their assets — or raising money for dedicated venture capital funds — to invest in these private companies, which have put off their initial public offerings.
Of course, some managers have also shifted their tech strategy more broadly, reallocating assets within TMT. That’s a subject we’ll pick up in more detail in part two, next week.
