Hedge Funds' Holdings in Financials: $70 Billion

Date: Wednesday, August 26, 2009
Author: Joseph Checkler, The Wall Street Journal

Hedge funds made an outsize bet on financial stocks in the second quarter, according to a closely watched report on hedge-fund holdings.

During the quarter, hedge funds increased their ownership in financial stocks by 55% to $70 billion, compared with the previous quarter. The funds now own 3.7% of the sector's market capitalization, according to a Goldman Sachs research report released Monday. That is an all-time high, the report said.

Among the funds' favorites were the big banks, including Bank of America Corp. and J.P. Morgan Chase & Co.

Undervalued Financials?

The Goldman "Hedge Fund Trend Monitor" report adds credence to the anecdotal evidence that hedge-fund managers thought financials were undervalued during the quarter, after a rough 2008 and start to 2009. The number of funds holding Bank of America more than doubled, while 38 hedge funds took first-time positions in J.P. Morgan.

The report defined financial stocks broadly, and included sectors such as banking conglomerates, consumer-finance companies and regional banks.

Hedge funds' move into financial stocks explains some of the second-quarter run-ups in these stocks. Questions remain about how long they will stay bullish on financial stocks, and how much more money a scaled-down industry can invest in bank stocks.

John Paulson, who runs Paulson & Co., bought 168 million shares of Bank of America and 35 million of regional bank Regions Financial Corp. during the second quarter. Mr. Paulson, famous for betting against subprime mortgages and financials in 2007 and some of 2008, also increased his stake in J.P. Morgan.

Other well-known managers, including SAC Capital, Maverick Capital and TPG-Axon, bought millions of shares of one or more banks.

Goldman's research, which looks at hedge funds' end-of-quarter 13-F holdings reports with the Securities and Exchange Commission, suggests that hedge funds' increased exposure was from buying in the open market, participation in equity raisings and short covering.

Net short exposure of financials rose only 8% to $63 billion, while long exposure increased 55% to $70 billion. Hedge funds were net long financials at the end of the second quarter, after being net short in the first.

The prices of most financial stocks increased even more than the overall stock market since the first quarter, so it is possible that what is now undervalued could soon be seen as overvalued.

Bank of America, J.P. Morgan and Regions, the three stocks with the most new hedge-fund holders during the second quarter, were among the biggest gainers in financials. By the second quarter's end, they owned 14% of Regions, up from just 2% at the end of the first quarter.

Buying Into Citi

Among financial conglomerates, J.P. Morgan and Bank of America weren't the only ones hedge funds bought. Several hedge funds added to stakes or took first-time positions in Citigroup Inc. Two such fund managers were Sandell Asset Management and Scoggin Capital.

Whether hedge funds continue buying financials depends in part on the health of the hedge-fund industry, which suffered big losses in 2008 but has made a bit of a comeback in 2009. Redemptions at hedge funds have eased, which means fewer hedge funds have been forced to sell stocks they might have preferred holding.

"Hedge funds' selling pressures have abated," the Goldman report said, "and smaller hedge funds do not appear as pressured as some investors had feared."

Write to Joseph Checkler at joseph.checkler@dowjones.com