It’s not the end of the carried interest loophole, but JPMorgan Chase & Co. believes there’s another way U.S. tax reform could end up hurting hedge funds.
“We think the market is underestimating the probability of tax reform passage; the potential performance risk to active managers with high exposure to growth/momentum could be significant in the near term,” writes equity derivatives strategist Shawn Quigg.
More than half of active managers have been able to beat their benchmark this year, the strategist claims, a phenomenon primarily attributable to a handful of holdings mostly in the tech sector that have become hedge-fund hotels. Many of those stocks slumped as markets become more optimistic about the prospects for U.S. tax reform, with the FANG quartet alone losing $60 billion in market capitalization.
The enactment of a tax overhaul bill is more likely to shift which types of stocks outperform more than the overall trajectory of the bull market, he argues. While Quigg sees tax reform giving mid-single-digit upside to the S&P 500 Index, he notes that because most investors have relatively high allocations to equities at present they may be less willing to boost their U.S. stock holdings.
Growth stocks have outperformed their value peers by roughly 15 percentage points in 2017 and by 55 percentage points during this bull market.
“For managers overweight growth/momentum, taking a defensive approach to tax reform appears prudent,” writes Quigg.
The strategist highlighted a handful of stocks that have hedge-fund ownership in excess of 5 percent and have been outperforming the Nasdaq 100 Stock Index by at least 50 percent this year to isolate the names most at risk of a violent rotation from growth to value. The list includes FANG components Facebook Inc. and Netflix Inc.