Update (3/11/2015): We published this article about hedge fund piggybacking more than 4 years ago. Two and a half years ago we launched an investment newsletter that aimed to identify the best stock picks of the best hedge fund managers. The actual returns of our 15 quarterly stock picks was beyond the dreams of our most subscribers. Our 15 quarterly stock picks returned 131.4% in 2.5 years whereas the S&P 500 ETF (SPY) gained only 57.2% during the same period. Our stock picks outperformed the market by more than 74 percentage points. You can read the details of our strategy and download a free sample issue here.
Hedge fund managers don’t have many original investment ideas. If you look at the top 10 stocks held by most hedge funds, you’ll see more than 100 hedge funds in each stock. As hedge fund assets grow as a result of inflows, hedge fund managers have no choice but to invest in stocks with marginal potential or larger market caps. As a result, there will be several hedge funds with similar holdings.
According to a WSJ article hedge fund returns are more correlated now than five years ago:
“An analysis of hedge-fund returns by Andrew W. Lo, a Massachusetts Institute of Technology researcher and fund manager, shows that funds have become more likely to lose and gain money together over the past five years. There is a roughly 79% chance any randomly selected pair of hedge funds will move up and down in tandem in a given month from 2006 to 2010, compared with a roughly 67% likelihood from 2001 to 2005, according to his analysis.”
The article states that many hedge fund managers share investment ideas through instant messaging, emails, private chats, and “idea dinners”. Research firms such as Monness, Crespi, Hardt & Co arranges these gatherings for more than a dozen hedge funds at a time. Other hedge fund managers use public message boards to field test their investment ideas. Daniel Loeb used to do this earlier in his career, using Mr. Pink as his screen name.
Last summer SEC dropped a two-year investigation that focused on Dan Loeb’s sharing of investment ideas with other hedge funds. Sharing investment ideas and discussing them publicly isn’t illegal as long as it isn’t done as part of a conspiracy to manipulate stock prices.
Hedge fund managers share ideas all the time. It’s a win-win for hedge fund managers. If one comes up with an original idea, it’s better to share those ideas with other hedge funds so that the stock price reflects the mispricing quicker. If the idea isn’t that great, then other fund managers won’t respond and this will give a feedback that it wasn’t really a great idea to begin with. Then, one can get rid of that investment and deploy capital to more efficient areas.
Insider Monkey follows hedge fund holdings and transactions in order to detect patterns and generate investment ideas. Then we monkey the most promising trades. We might not be able to match hedge funds’ gross returns but we may achieve returns that are higher than their “net returns”.