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Did Hedge Funds Make The Right Call On KAR Auction Services Inc (KAR)?

The latest 13F reporting period has come and gone, and Insider Monkey have plowed through 821 13F filings that hedge funds and well-known value investors are required to file by the SEC. The 13F filings show the funds’ and investors’ portfolio positions as of March 31st, a week after the market trough. Now, we are almost done with the second quarter. Investors decided to bet on the economic recovery and a stock market rebound. S&P 500 Index returned almost 20% this quarter. In this article you are going to find out whether hedge funds thoughtKAR Auction Services Inc (NYSE:KAR) was a good investment heading into the second quarter and how the stock traded in comparison to the top hedge fund picks.

KAR Auction Services Inc (NYSE:KAR) has seen a decrease in hedge fund interest of late. Our calculations also showed that KAR isn’t among the 30 most popular stocks among hedge funds (click for Q1 rankings and see the video for a quick look at the top 5 stocks).

Video: Watch our video about the top 5 most popular hedge fund stocks.

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 58 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.

Jeffrey Gates of Gates Capital

At Insider Monkey we scour multiple sources to uncover the next great investment idea. Cannabis stocks are roaring back in 2020, so we are checking out this under-the-radar stock. We go through lists like the 10 most profitable companies in the world to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. If you want to find out the best healthcare stock to buy right now, you can watch our latest hedge fund manager interview here. With all of this in mind let’s go over the key hedge fund action encompassing KAR Auction Services Inc (NYSE:KAR).

Hedge fund activity in KAR Auction Services Inc (NYSE:KAR)

At Q1’s end, a total of 21 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -19% from the previous quarter. The graph below displays the number of hedge funds with bullish position in KAR over the last 18 quarters. So, let’s review which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

Among these funds, Gates Capital Management held the most valuable stake in KAR Auction Services Inc (NYSE:KAR), which was worth $89.4 million at the end of the third quarter. On the second spot was Cardinal Capital which amassed $48.5 million worth of shares. Citadel Investment Group, AQR Capital Management, and Arrowstreet Capital were also very fond of the stock, becoming one of the largest hedge fund holders of the company. In terms of the portfolio weights assigned to each position Gates Capital Management allocated the biggest weight to KAR Auction Services Inc (NYSE:KAR), around 5.89% of its 13F portfolio. SkyTop Capital Management is also relatively very bullish on the stock, setting aside 4.89 percent of its 13F equity portfolio to KAR.

Since KAR Auction Services Inc (NYSE:KAR) has experienced a decline in interest from the smart money, logic holds that there lies a certain “tier” of hedge funds that slashed their entire stakes last quarter. Intriguingly, Renaissance Technologies dropped the largest investment of the “upper crust” of funds followed by Insider Monkey, totaling about $16.8 million in stock, and David MacKnight’s One Fin Capital Management was right behind this move, as the fund said goodbye to about $6 million worth. These transactions are intriguing to say the least, as aggregate hedge fund interest fell by 5 funds last quarter.

Let’s now review hedge fund activity in other stocks – not necessarily in the same industry as KAR Auction Services Inc (NYSE:KAR) but similarly valued. We will take a look at ForeScout Technologies, Inc. (NASDAQ:FSCT), Kennametal Inc. (NYSE:KMT), Albany International Corp. (NYSE:AIN), and FormFactor, Inc. (NASDAQ:FORM). This group of stocks’ market caps resemble KAR’s market cap.

Ticker No of HFs with positions Total Value of HF Positions (x1000) Change in HF Position
FSCT 33 421646 12
KMT 17 147627 -2
AIN 18 51239 -1
FORM 22 92958 0
Average 22.5 178368 2.25

View table here if you experience formatting issues.

As you can see these stocks had an average of 22.5 hedge funds with bullish positions and the average amount invested in these stocks was $178 million. That figure was $204 million in KAR’s case. ForeScout Technologies, Inc. (NASDAQ:FSCT) is the most popular stock in this table. On the other hand Kennametal Inc. (NYSE:KMT) is the least popular one with only 17 bullish hedge fund positions. KAR Auction Services Inc (NYSE:KAR) is not the least popular stock in this group but hedge fund interest is still below average. This is a slightly negative signal and we’d rather spend our time researching stocks that hedge funds are piling on. Our calculations showed that top 10 most popular stocks among hedge funds returned 41.4% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks gained 18.6% in 2020 through July 27th and surpassed the market by 17.1 percentage points. Unfortunately KAR wasn’t nearly as popular as these 10 stocks (hedge fund sentiment was quite bearish); KAR investors were disappointed as the stock returned 18.7% since Q1 and underperformed the market. If you are interested in investing in large cap stocks with huge upside potential, you should check out the top 10 most popular stocks among hedge funds as most of these stocks already outperformed the market in 2020.

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Disclosure: None. This article was originally published at Insider Monkey.