Here’s how Facebook and other hedge-fund favorites are biting into returns

2018 is shaping up as a tough year for equity hedge funds. A look at their favorite stocks, including Facebook, helps explains why, say analysts at Goldman Sachs.

In a late Monday note, the analysts said that nearly 100 hedge funds owned social-media giant Facebook Inc. FB, +0.59%  as a top 10 holding at the beginning of the third quarter, keeping it at the top of Goldman’s Hedge Fund VIP list and weighing on performance as shares plummeted in July. Facebook shares fell more than 11% in July, continuing a volatile year. Shares are up 0.5% so far this month, leaving them down 1.7% in the year to date.

Goldman, whose VIP list tracks the most popular long positions held by 830 hedge funds, has suffered large performance swings this year (see chart below), lagging behind the S&P 500 SPX, +0.51%  by 500 basis points since June, the analysts said.

Declining net leverage as the equity market rebounded from its February swoon was another drag, the analysts said, while also noting that the biggest targets for short bets—wagers that stock prices will fall—have actually outperformed this year.

Goldman found that a basket of the 50 Russell 3000 RUA, +0.57%  stocks with market caps of more than $1 billion and the largest outstanding short interest as a share of float has outperformed the S&P 500 by 14 percentage points, up 21% year to date versus 7% for the large-cap index.

After Facebook, the next most popular long positions were in Amazon.com Inc. AMZN, +1.09% Microsoft Corp. MSFT, +0.08% Google parent Alphabet Inc. GOOGL, +0.66% and NXP Semiconductors NV NXPI, +1.89% The top five have averaged a 0% return since the start of the third quarter, but have outperformed the S&P 500 in 62% of quarters since 2001, generating an average quarterly excess return of 54 basis points, or 216 basis points annually, Goldman said.

Meanwhile, Facebook’s plunge probably accelerated a rotation away from the technology sector to health-care stocks that was already in progress, Goldman said. Before its disappointing second-quarter earnings results, 230 hedge funds, accounting for 28% of Goldman’s sample, owned Facebook, making it the most popular position, with an average portfolio weight among those funds of 4%.

At the start of the year, 20 stocks in Goldman’s VIP list came from the tech sector, putting its share at 40%, the highest on record, the analysts said. At the time, only three health-care stocks, accounting for 6% of the basket, were on the list, the lowest representation since 2008. Goldman said its newly rebalanced basket shows a”modest shift” from tech to health care among the most popular positions, continuing a rotation that started in mid-2017.

Meanwhile, overweight positions in health care have been rewarded thanks to the combination of info tech volatility, mergers and acquisitions, and the easing of policy concerns, the analysts said. Health care has outperformed the S&P by 500 basis points over the last three months, they said.