Value stocks have been underperforming growth stocks by 9 percentage points annually since the middle of 2017 and this is hurting the performance of value investors. Here is what legendary billionaire value investor Seth Klarman whose hedge fund returned less than 10% in 2019 said about hedge funds:
“The hedge fund ecosystem that expanded rapidly a decade ago is now experiencing retrenchment. Human nature being what it is, the Great Financial Crisis raised fear levels, and many investors flocked into hedged vehicles or other “alternative assets.” Investors bought into the concept of achieving strong but uncorrelated returns with downside protection. Overall, hedge fund assets more than doubled from 2008 to 2015. Unsurprisingly, as their assets were surging, it became harder for hedge funds to differentiate themselves from the pack and to add value. As markets more than quadrupled off the 2009 lows, hedge fund performance in the aggregate began to significantly lag the leading equity market indices, especially after fees. A decade of steady market gains racked up by traditional long-only and index products has made many asset allocators less interested in hedged strategies.
As a result of lagging performance over this period, many hedge funds have experienced significant redemptions and some have closed. In 2019 through November, an estimated $82 billion was pulled out of hedge funds, more than twice as much as in 2018. For each of the past four years, more hedge funds have closed than opened. This, in turn, is putting selling pressure on stocks and other securities widely owned by hedge funds, precipitating a vicious circle of underperformance: selling leading to falling prices, which in turn drive poor performance and redemptions, driving further selling, leading to even worse results.”
Seth Klarman may be right about value hedge funds but what he forgets is that not every hedge fund is a value hedge fund. We have been sharing the list of 30 most popular stocks among hedge funds here at Insider Monkey for the past year. Actually the majority of these stocks aren’t traditional value stocks. Last quarter we listed hedge funds’ top 30 stock picks at the end of the third quarter of 2019. While the S&P 500 ETFs returned around 9.0% during the fourth quarter, hedge funds’ top 20 stock picks crushed the market with a 13.5% gain. Overall, hedge funds’ top 20 stock picks returned 41.3% in 2019 and beat the market by 10.1 percentage points. Below, you can watch our video about hedge funds’ top 5 stock picks. The list of top 5 stock picks didn’t change from Q3 to Q4.
Video: 5 Most Popular Stock Among Hedge Funds
I wish Seth Klarman were an Insider Monkey subscriber. He wouldn’t have made this simple mistake about why hedge funds are experiencing outflows. As you can see, hedge funds’ top picks beat the market by 10 percentage points, yet on an overall basis hedge funds saw outflows. There are two main reasons. First, hedge funds are hedged. Even though they beat the market on the long side, their short stock picks also rise during strong bull markets and bring down their gross returns. Second, hedge funds charge an arm and a leg for their services. You could have invested in the top 20 hedge fund stocks in 2019 by yourself without paying a dime to anyone and beat the market by 10 percentage points. Unfortunately a hedge fund that generates a 41% gross return, charges close to 2 points in management fees and 8 points in performance fees bringing down their investors’ net returns to 31%.
Hedge funds’ top stock picks don’t change much from quarter to quarter. So, the 45 day delay in 13F filings doesn’t materially affect the performance of investors who are riding the coattails of successful hedge fund managers. The top 20 stocks among hedge funds at the end of December are performing spectacularly so far in the fourth quarter. The top 20 stocks among hedge funds returned 8.9% through February 18th and outperformed the market by another 4.3 percentage points. Since the end of 2018 hedge funds’ top picks returned 53.8% and beat the market’s 37.3% gain by 16+ percentage points.
Insider Monkey’s mission is to identify promising (and also terrible) hedge fund stock pitches and share them with our subscribers. We launched our monthly newsletter’s activist strategy 3 years ago and this strategy’s picks returned 90% in 3 years and beat the market’s 47% gain by 43 percentage points. Our short strategy was also launched 3 years ago and its short recommendations lost a cumulative 19% (that’s a good thing because we are shorting them) since then. You can support our website by subscribing to our premium newsletters.
Nowadays most investors believe that hedge funds lost their “magic touch” a long time ago and can’t beat the market. Don’t trust the returns reported by hedge fund indices. Hedge funds underperform because they hedge. If you want to compare apples to apples, you need to take a look at the performance of most popular hedge fund stocks vs. the returns of the S&P 500 Index. Apple, Google, Microsoft, Facebook, and Amazon have consistently been among the top 3 hedge fund picks over the last 7 years since we started publishing our quarterly newsletter. You don’t have to be a math wizard to calculate the mind numbing returns of these technology stocks some of which now trade around $1 trillion valuation.
The best thing about following hedge funds’ top picks is that you don’t need to pay them an annual 2% fee and 20% of your profits to beat the market. We do that here free of charge using the holdings data from the legally required SEC portfolio disclosures. Our approach is also superior to investing directly into hedge funds because we don’t like to invest in a hedge funds’ 35th best idea when we can invest in only the best stock picks of the best hedge funds.
Below we listed the 30 most popular stocks among hedge funds at the end of December (you can also watch our video above covering the top 5 hedge fund stocks). If you are only interested in large-cap stocks, check out the top 20 stocks in this list below:
30. Nike Inc (NYSE:NKE): $102
Number of Hedge Funds: 81
Total Dollar Amount of Long Hedge Fund Positions:$2.5 billion
Percent of Hedge Funds with Long Positions: 9.8%
First Quarter Return (through February 18th): 0.7%
Popularity Ranking (Q3): 44
Noteworthy Hedge Fund Shareholders: Nicolai Tangen, Cliff Asness