Selloff in Highly Priced Tech Stocks Is Pressuring Hedge Funds That Piled In

(Bloomberg) — Losses are picking up in very-high-priced technology stocks that had recently grown in popularity among hedge funds.

Farfetch Ltd. and Snowflake Inc. fell, driving a basket of software and internet companies that have yet to earn any money down more than 5%, its biggest decline since March, data compiled by Goldman Sachs Group Inc. show. Farfetch plunged 14% after the online apparel retailer trimmed its full-year forecast for digital growth. Snowflake, a software developer due to report results next week, sank 9%.

That’s bad news for hedge funds who just boosted exposure to high-growth, high-valuation stocks to extreme levels. At the start of the fourth quarter, companies with enterprise value exceeding 10 times sales accounted for a third of their equity holdings, the highest level since at least 2002, according to data from fund filings compiled by Goldman.

A lack of profits had until recently done little to dissuade investors betting that rock-bottom interest rates will justify valuations for expensive stocks such as technology. Now as the bond market has started to price in higher odds of rate hikes next year after President Joe Biden picked Jerome Powell for a second term at the head of the Federal Reserve, investors may be reconsidering their appetite.

“While many of these high-growth, low-profit companies have attractive outlooks, the dependence of their current valuations on long-term future cash flows makes them particularly vulnerable to the risks of rising interest rates or disappointing revenues,” Goldman strategists led by David Kostin, wrote in a Friday note.

It could be bad timing or it could be a case of selling begetting selling, considering the growing concentration of these stocks in the portfolios of professional speculators. Notable losses in a few companies that don’t fit the high-priced tech definition but are also hedge-fund favorites — Visa Inc. and Mastercard Inc., for instance — could be evidence that positions are being unwound.

The pain is not limited to hedge funds. Another devotee of growth stocks, the famed money manager Cathie Wood, saw her flagship ARK Innovation ETF (ARKK) drop more than 4%, extending its monthly slide to 11%. Another fund, ARK Genomic Revolution ETF (ARKG), sank 5% to a one-year low.

Hedge funds might have doubled down on super-growth stocks, seeking to catch up with the market amid favorable year-end trends, according to Michael Purves, founder of Tallbacken Capital Advisors. Thanks to the drag from bearish bets and spotty stock picking, the industry has struggled to keep up with the market, with those tracked by Hedge Fund Research Inc. returning 12% this year. That’s less than half the gain of the S&P 500.

With their concentrated bets going awry, fund managers could be forced to unwind the positions as the window for the annual book is quickly closing.

“I’m guessing they figured a big broad equity gain would lift all boats into year end, and that you would get outperormance from higher volatility/higher beta stocks,” said Purves. “If hedge funds were really bulled up, they have to suddenly de-risk that exposure that will exacerbate” the selloff, he added.

To Dennis DeBusschere, founder of 22V Research, the retreat coinciding with a selloff in the cryptocurrency market may hurt sentiment of the retail crowd, whose wealth has appreciated significantly amid a rally in some of the riskiest corners of financial markets.

“A puke in unprofitable Tech will worry some people, especially if it translates into further drawdown of Bitcoin/other crypto,” he said. “Just about all investors I talk to are worried about the consequences of a large move lower in the crypto related” space.