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The stellar performance of technology stocks in 2020 amid the COVID-19 pandemic has led to outsized returns for investors who have placed bets in technology stocks. The tech-heavy NASDAQ Composite rose 43.64% in 2020, posting the highest return recorded by the index since 2009 and outperforming the broader S&P 500 which rose 16.26%. Technology stocks benefited from the COVID-19 induced lockdowns as people brought forward their technology purchases to enable themselves to work from home productively and stay connected to their friends and colleagues. In addition, technology stocks were also supported by the Federal Reserve’s emergency move in March 2020 to cut benchmark interest rates to zero and restart quantitative easing. As technology stocks are generally regarded as long-duration, the fall in interest rates increased the present value of their future earnings by a larger extent and supported their share prices.

Ever since the announcement of the successful election of Joe Biden as the 46th president of the United States, equity market risk-on sentiment has been rising as investors looked forward to Joe Biden leading his country out of the COVID-induced recession through the implementation of large economic stimulus packages and roll out of vaccination programs. The US government has already passed a total of US$5 trillion in fiscal stimulus to support the US economy, an amount which is greater than the GDP of Germany. The unprecedented level of economic stimulus caused concerns among investors as uncertainties rose over how the Federal Reserve would react, given the fact that they recently adopted a framework which allows the inflation rate to rise above its target. Although recent inflation data in the United States showed that consumer prices remained muted in recent months, the five-year inflation expectation has risen to its highest level in more than a decade. This has resulted in a huge spike in the yields of longer tenure bonds, with the yield on the 10-year Treasury note rising from the March 2020 low of 0.325% to 1.407% by the end of February 2021. In terms of their early 2021 performance, the NASDAQ composite has already declined 6.41% from its peak of 14,095.47 on 12 February 2021 to end the month at 13,192.35. By comparison, the broader S&P 500 Index has declined relatively lower at 3.14% over the same period, suggesting that investors are increasingly shifting their bets away from the technology sector.

In this report, we will examine the risk-return profile of tech-focused hedge funds as represented by the Custom Eurekahedge Tech-Focused Hedge Fund Index and assess their attractiveness relative to the average hedge fund and their strategic peers. The Custom Eurekahedge Tech-Focused Hedge Fund Index is an equal-weighted index comprising 60 active hedge funds which heavily invest in the technology sector. Since end-2007, the custom index tracked a total of 102 hedge funds including liquidated funds. Hedge funds with portfolios concentrated in the technology sector as indicated in their industry focus and strategy description were included in the index. Hedge funds with only minor exposure to the technology sector are not part of the index.

Figures 1a and 1b show the breakdown of the Custom Eurekahedge Tech-Focused Hedge Fund Index by strategic mandate in 2008 and 2020 respectively. As can be seen in the figures, long/short equities has remained as the most popular strategy among tech-focused hedge funds, accounting for 81.3% of the index. The bottom-up strategy has also become more popular over the years, with their share of the index growing from 2.8% in 2008 to 6.7% in 2020. On the other hand, the dual approach strategy has seen their share of the index decline from 5.6% in 2008 to 2.7% in 2020.

Figures 1a-1b: Index breakdown by strategic mandate

Figures 2a and 2b show the breakdown of the Custom Eurekahedge Tech-Focused Hedge Fund Index by geographic mandate in 2008 and 2020 respectively. Since the aftermath of the global financial crisis, the global mandate has increased in popularity as investors look to add more diversification to their portfolio. This has enabled tech-focused hedge funds with a global mandate to grow their share of the index from 38.9% in 2008 to 54.7% in 2020. On the other hand, tech-focused hedge funds with a North American mandate have seen their share of the index decline from 44.4% in 2008 to 25.3% in 2020.

Figures 2a-2b: Index breakdown by geographic mandate

Figure 3: Performance of tech-focused hedge funds against benchmarks since the end of 2007

Figure 3 compares the performance of the Custom Eurekahedge Tech-Focused Hedge Fund Index against the Eurekahedge Value Absolute Return Fund Index. In general, technology stocks have higher P/E ratios as investors anticipate strong earnings growth in the future i.e., Amazon P/E ratio is 73x compared to 20x of Walmart. On the other hand, value absolute return funds invest in companies which are fundamentally undervalued due to market mispricing. In the following charts and tables, we compare the performance of both strategies in terms of their risk-return statistics. Figure 3 also displays the performance of long/short equities hedge funds, global hedge funds and the NASDAQ composite for comparison.

As observed in figure 3, tech-focused hedge funds have managed to return 12.22% per annum, outperforming their value absolute return, long/short equities peers and the average global hedge fund by a large margin as they returned 4.72%, 6.24% and 5.89% per annum respectively since the end of 2007. The NASDAQ Composite performed slightly better than the tech-focused hedge funds, generating an annualised return of 12.96% over the same period.

Table 1 provides the detailed risk return statistics of the five indices shown in the figure above. Key takeaways include:       

1. The Custom Eurekahedge Tech-Focused Hedge Fund Index outperformed their value absolute return peers and other benchmarks in terms of both annualised return and risk-adjusted return. Over the last 10 years, tech-focused hedge funds have generated an annualised return of 13.55%, outperforming their long/short equities and value absolute return peers which generated an annualised return of 6.82% and 6.16% respectively but trailed behind the NASDAQ Composite which recorded 16.84% annualised return. In terms of risk-adjusted return, tech-focused hedge funds also yielded a better Sharpe ratio of 1.31 compared to their peers, as shown in Table 1.


2. In a rising interest rate environment, technology stocks are expected to decline more sharply than other sectors due to their long-dated future cash flows. In 2016 when the Federal Reserve started to hike their fed funds rate resulting in an increase in the US10Y yield, the tech-focused hedge funds underperformed their peers as they only gained 0.40%, while their value absolute return, long/short equities and global hedge fund peers returned 13.57%, 3.87% and 4.82% respectively. It is also worth noting that over the period from 2009 to 2020, 2016 was the only year that both long/short equities hedge funds and global hedge funds managed to outperform tech-focused hedge funds.


3. As a result of the escalating US-China trade war, tech-focused hedge funds underperformed against other benchmarks in Q4 2018 as the index was down 10.45% compared to the 4.20% decline of the Eurekahedge Hedge Fund Index. Despite the dismal Q4 2018 performance, the strong performance of the Custom Eurekahedge Tech-Focused Hedge Fund Index in the earlier months of the year, particularly in January and May when the NASDAQ composite returned 7.40% and 5.30% respectively, have allowed the index to outperform their other benchmarks in 2018


4. Tech-focused hedge funds have consistently generated positive annual returns since the aftermath of the 2008 global financial crisis, with 2018 being the only exception as they lost 2.79% during the year. Tech-focused hedge funds have also persistently outperformed the Eurekahedge Hedge Fund Index and the Eurekahedge Long Short Equities Hedge Fund Index over the past three-, five- and ten-year periods as shown in the table above.


5. Hedge fund managers comprising the Custom Eurekahedge Tech-Focused Hedge Fund Index have generated exceptional Sharpe ratios over the past decade, outperforming the other indices by a notable margin. Despite having a higher annualised volatility compared to long/short equities and global hedge funds, tech-focused hedge funds recorded a higher Sharpe ratio, supported by their strong annualised return. Over the last three years, tech-focused hedge fund managers have generated a Sharpe ratio of 1.36. In comparison, the Eurekahedge Long Short Equities Hedge Fund Index and the Eurekahedge Hedge Fund Index have generated Sharpe ratios of 0.69 and 0.71 respectively over the same period.

Figure 4 provides the 12-month rolling alpha of the Custom Eurekahedge Tech-Focused Hedge Fund Index against the Eurekahedge Long Short Equities Hedge Fund Index, and the Eurekahedge Hedge Fund Index, assuming a risk-free rate of 0%. Tech-focused hedge funds have generated significant positive alpha against the benchmark indices over the past 12 years. As a result of the pandemic-induced surge in the prices of technology stocks in 2020, tech-focused hedge funds have seen their alpha generated increasing during the year, reaching a peak in December 2020. Since then, bond yields have been on the rise, negatively impacting the performance of technology stocks as investors shift their bets away from the technology sector. This has led to a corresponding decrease in the positive alpha generated by tech-focused hedge funds, as seen in figure 4 below. If bond yields continue increasing, we would expect the trend of declining positive alpha to continue into 2021.

Figure 4: 12-month rolling Alpha of tech-focused hedge funds against benchmarks (RFR = 0%)

Source: Eurekahedge

Figure 5 provides the performance distribution of all tech-focused hedge funds in the Eurekahedge database, showing the median return, 10th and 90th percentile returns, as well as the top and bottom quartile returns on a yearly basis since 2008. Since 2010, the return dispersion among tech-focused hedge funds has remained consistently below the levels seen in 2009 when the NASDAQ Composite strongly rebounded 43.89% after the crash in 2008. In 2016 when increasing interest rates caused headwinds to the performance of tech-focused hedge funds, the top 10% of tech-focused hedge funds only managed to return 13.24%, significantly lower than the 18.77% of the top 10% of global hedge funds. Going into 2020, the return dispersion has widened significantly from 2019 levels, with the top 10% of tech-focused hedge funds generating an average return of 78.1% during the year. As investors’ expectations for inflation increase, the stellar performance of tech-focused hedge funds may not be sustained into 2021 as higher bond yields impact the prices of technology stocks more significantly than stocks in non-technology sectors.

Figure 5: Performance distribution of tech-focused hedge funds

With rising 10-year bond yields in the US, the tech-sector is likely to come under pressure which will create challenges for tech-focused hedge fund managers on the long side of their books. However, in the interim we believe this will continue to provide good opportunities for managers on the short side of their book as valuations moderate and the tech rally gets some much-needed grounding. Having said that, given the diverse applications of technology across different sub-sectors of the economy, i.e. from health care to automotive to e-commerce and social media - we will continue to see wide dispersion in underlying returns for fund managers as they actively tilt and manage their exposures across various sub-sectors in the technology space to ride the market gyrations of the next decade.

The full article inclusive of all charts and tables is available in The Eurekahedge Report accessible to paying subscribers only.

Subscribers may continue to login as usual to download the full report and non-subscribers may email database@eurekahedge.com to enquire on how to obtain the full research report.