Hedge funds as a group have been underperforming the S&P 500 index for a very long time, and this doesn’t sit well with investors. The reason is simple. Investors don’t really know that hedge funds are hedged. Hedge funds can’t beat the market because most hedge fund managers aren’t good short-investors and their long positions usually don’t outperform the market by a large enough margin to make up the short fall. So, in general it isn’t a brilliant idea to invest in an average hedge fund.
However, there are still two ways of taking advantage of the investment prowess of hedge fund managers. Our research has discovered that the most popular stocks among hedge funds have historically outperformed the S&P 500 index by 18 percentage points per year. This sounds impressive – but we also wanted to see whether these historical results would persist. So we launched a newsletter at the end of August and shared the stock picks of this strategy. Our stock picks gained more than 35% since then vs. S&P 500 index’s 12% return (see the details here).
Another way of investing in hedge funds is picking hedge fund managers with outstanding track records. We recently came across an under-the-radar hedge fund manager who can produce alpha both on the long side and the short side of his portfolio. Our quantitative analysis shows that his alpha is even slightly better than David Einhorn’s alpha.
Michael Castor of Sio Capital Management, LLC is a medical doctor (he used to be a surgeon) by training, but switched to finance in mid 2000. He worked as a healthcare analyst at JP Morgan and Bernstein Investment Research and Management until he launched Sio Capital in 2006. Academic studies have shown that small hedge funds and hedge funds focusing on a specific sector perform better than other hedge funds. Sio Capital returned 10.4% a year since its inception vs. 3.8% average annual gain for the S&P 500 Total Return Index during the same period. But this isn’t why we like Sio Capital. We like Sio Capital because they achieved a 6.6 percentage point outperformance with a nearly market neutral portfolio. Its beta was 0.15 since inception. Sio Capital was also 12% net short in 2012, yet it returned 14.9% after fees and expenses.
This is what we call alpha.