Hedge Funds Were Selling These 10 Mid-Caps In Q3, Part 2

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A widespread approach to diversifying an investor’s equity portfolio is to complement a pool of investments in large-cap stocks with a similar allocation to small-cap and mid-cap stocks. The S&P Mid-Cap 400 Index has returned 6.87% annually over the past ten years, which compares with the 5.16% annualized return generated by the S&P 500 over the same period. Mid-cap companies provide a wide range of advantages to investors. These well-established companies offer an appealing mix of high earnings growth and realistic valuations (cheap valuations relative to the broader market in some instances), steady long-term financial performance, and historical outperformance, as mentioned above. Most importantly, some companies from the mid-cap space can represent potential merger targets, which represents another strong reason for investing in this somewhat overlooked corner of equity markets. The Insider Monkey team already discussed ten mid-cap companies that attracted substantial attention from the hedge fund industry in the third quarter. So let’s take a different approach in this article, and look at five mid-cap companies that hedge funds from our database were deserting during the previous quarter. This is the second-part of a two-part feature, with the first part containing five other companies, including Viacom, Inc. (NASDAQ:VIAB).

SanDisk Corporation (NASDAQ:SNDK)

 – Investors with Long Positions (as of September 30): 38

 – Aggregate Value of Investors’ Holdings (as of September 30): $1.02 Billion

SanDisk Corporation (NASDAQ:SNDK) lost a fair bit of its charm among the hedge funds tracked by Insider Monkey during the September quarter, as the number of top money managers invested in the company decreased to 38 from 50 during the rough three-month period. The remaining shareholders held 9.20% of the company’s outstanding common stock on September 30. The global leader in NAND flash storage solutions is being acquired by Western Digital Corp (NASDAQ:WDC), which stresses the aforementioned point of why mid-cap companies represent great investment opportunities. Under the terms of the merger deal, SanDisk shareholders are set to receive $85.10 per share in cash and 0.0176 shares of WDC if a previously-announced investment in Western Digital by a subsidiary of Unisplendour Corporation closes before the completion of the merger. If the investment does not close prior to the merger, WDC shareholders will receive $67.50 per share in cash and 0.2387 shares of WDC. All-in-all, shares of SanDisk have gained 38% since the beginning of the fourth quarter, so most hedge fund vehicles failed to recognize the tempting merger target SanDisk would become after its market cap fell heavily throughout the first nine months of the year. Michael Lowenstein’s Kensico Capital holds a 4.29 million-share position in SanDisk Corporation (NASDAQ:SNDK) as of September 30.

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Starwood Hotels & Resorts Worldwide Inc. (NYSE:HOT)

 – Investors with Long Positions (as of September 30): 47

 – Aggregate Value of Investors’ Holdings (as of September 30): $3.61 Billion

47 hedge funds from our extensive database were invested in Starwood Hotels & Resorts Worldwide Inc. (NYSE:HOT) at the end of the September quarter, compared with 62 reported at the end of the previous one. Even so, these hedge fund investors amassed a whopping 31.90% of the company’s outstanding common stock at the end of the quarter. In mid-November, Marriott International Inc. (NASDAQ:MAR) and Starwood sealed a merger agreement, which will create the largest hotel company in the world. The terms of the agreement say that Starwood shareholders will receive 0.92 Marriott shares and $2.00 in cash for each share of Starwood. The shares of Starwood are up by 6% thus far in the fourth quarter, so several hedge funds abandoned their investments in the hotel and leisure company too early. Billionaire John Paulson of Paulson & Co. upped its position in Starwood Hotels & Resorts Worldwide Inc. (NYSE:HOT) by 30% during the July-to-September period, ending the quarter with 15.60 million shares.

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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 more than 80 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 (read the details). That’s why we believe investors should pay attention to what hedge funds are buying (rather than what their net returns are).

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