Hedge Funds Were Right to Ditch These Sinking Stocks, Part 1

Although hedge funds don’t always get it right, they outperform the market when factoring in known risk factors because of the in-depth research and the world-class, financially-savvy workforce that they employ. With many Ivy League graduates and extensive industry connections at their disposal, hedge funds often see sector downturns before everyone else. In this article we examine five stocks that the hedge funds tracked by Insider Monkey became less bullish on in the third quarter, ahead of them sinking (or continuing to sink) in the fourth quarter. Those stocks are Devon Energy Corp (NYSE:DVN), Whiting Petroleum Corp (NYSE:WLL), Magna International Inc. (USA) (NYSE:MGA), Dynegy Inc. (NYSE:DYN), and Canadian Pacific Railway Limited (USA) (NYSE:CP). In Part 2 of this two-part feature, we’ll cover five more stocks that smart money was wisely getting rid of during the third quarter.

Most investors don’t understand hedge funds and indicators that are based on hedge funds’ activities. They ignore hedge funds because of their recent poor performance in the bull market. Our research indicates that hedge funds underperformed because they aren’t 100% long. Hedge fund fees are also very large compared to the returns generated and they reduce the net returns experienced by investors. We uncovered that hedge funds’ long positions actually outperformed the market. For instance the 15 most popular small-cap stocks among funds beat the S&P 500 Index by 53 percentage points since the end of August 2012. These stocks returned a cumulative of 102% vs. a 48.7% gain for the S&P 500 Index (see the details here). That’s why we believe investors should pay attention to what hedge funds are buying (rather than what their net returns are).

#5 Canadian Pacific Railway Limited (USA) (NYSE:CP)

 – Number of Hedge Fund Holders (as of September 30): 39
– Total Value of Hedge Fund Holdings (as of September 30): $3.98 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 17.80%

The number of elite funds long Canadian Pacific Railway Limited (USA) (NYSE:CP) dropped by 12 to 39 during the third quarter, with many funds likely selling before the stock made a major down move in August. Shares are down by another 14% in the fourth quarter. With oil and gas prices so low, demand for oil and coal train shipments isn’t what it used to be and investors are no longer as optimistic about the stock. Canadian Pacific shares could have some additional short-term downside if the company ramps up its bid to acquire Norfolk Southern Corp. (NYSE:NSC). Canadian Pacific originally bid $28.4 billion for the company, but its offer was rejected. Bill Ackman‘s Pershing Square owned 13.94 million CP shares at the end of September.

#4 Dynegy Inc. (NYSE:DYN)

 – Number of Hedge Fund Holders (as of September 30): 40
– Total Value of Hedge Fund Holdings (as of September 30): $1.18 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 44.30%

With Dynegy Inc. (NYSE:DYN) shares retreating by 29.3% from June 30 to September 30, it isn’t surprising that the total number of elite funds long the stock fell to 40 from 52 during the same time frame. Because of weaker industry conditions and warmer weather, Dynegy’s outlook isn’t as bright as it once was. Management expects 2015 adjusted EBITDA to be $825 million-to-$925 million, down from the previous guidance of $825 million-to-$1.025 billion. Management also expects 2016 adjusted EBITDA to be $1.1 billion-to-$1.3 billion and 2016 free cash flow to be $300 million-to-$500 million, both of which are below expectations. Israel Englander‘s Millennium Management cut its Dynegy stake by 37.3% to 2.76 million shares. Those shares have lost another 47% of their value in the fourth quarter.