Hedge fund managers have a hard time delivering market-beating returns to their investors. The last seven years have proven testament to that, with the average return of hedge funds underperforming the market every single year since 2008. This of course begs the question, “why bother tracking and worrying about what hedge funds are doing; shouldn’t they and their ill-fated picks be avoided like the plague?” Well, yes and no. And by yes, we mean do avoid their large-cap picks, and by no, don’t avoid their small-cap picks.
Why is this? Well, our historical analysis of more than a decade’s worth of 13F filings from many of the top hedge funds in the world shows that the majority of their money gets funneled into large cap stocks that can’t generate enough alpha to spoil investors with strong returns; the money is simply pushed into large-cap sources to use it up and collect fees from it.
This is exemplified by the returns of Dan Loeb’s Third Point since 1999. By analyzing the fund’s 13F filings between 1999 and 2012, we found that its top five large-cap (companies with a market cap of more than $20 billion) stock picks, equally weighted, returned just 0.05% monthly during this timeframe, drastically underperforming the returns of the S&P 500 (0.35%). The news is even worse when we limit the data to between the years 2008 through 2012, during which those top large-cap picks actually lost 0.05% per month, versus the S&P 500 growth of 0.29%.
On the other hand, fund managers are extremely adept at generating returns from their top small-cap stock picks; in fact their top 15 picks, collectively, have outperformed the market annually by a rate in the double digits! This is why Loeb’s fund has generated average annualized returns of 17.3% since its inception in late 1996, despite the vast underperformance of its large-cap picks during much of that time. Funds like Third Point simply don’t have enough of their capital invested in small-caps to be able to offset the marginal returns from large-caps.
Needless to say, historical data tells us that Loeb’s large-cap picks should probably be avoided. With that in mind, let’s take a look at five of Loeb’s top large-cap stock picks at the end of 2014.
Alibaba Group Holding Ltd (NYSE:BABA), the $213 billion Chinese e-commerce giant tops our list, with Loeb owning 10 million shares at the end of 2014 worth $1.04 billion at the time, after increasing his stake by 2.80 million shares during the fourth quarter. Let’s stress “at the time”, as Alibaba has plunged over 17% this year, wiping out more than $170 million of Loeb’s stake.
Alibaba has made several moves in recent days to further its global expansion in e-commerce and entertainment, acquiring an 8.8% stake in Enlight Media, a Chinese movie and television production company. The company also opened its first U.S cloud center this week, in Silicon Valley. These moves however are unlikely to have a short term positive effect on the company’s growth, which investors will be paying specific attention to when Alibaba releases its next quarterly results. For this reason, many analysts are bearish on Alibaba short term, with a more bullish long-term outlook.