Bundling is a genius marketing and sales tactic that is employed by several industries to boost their revenues. For example consumers pay a slightly lower price if they buy fries and a drink together with their cheeseburgers. Your cable company doesn’t even offer subscriptions to individual channels. You have to subscribe to all 100+ TV channels if you’d like to get their cable TV service. This practice forces consumers to pay for TV channels that they may never watch.
Hedge funds use the same trick. Billionaire Larry Robbins had 48 stocks in his 13F portfolio at the beginning of this year. Obviously some of these are great ideas and some aren’t. Why would anyone want to pay Larry Robbins 2% of his/her capital and 20% of potential profits (but not losses) for his 48th best idea? This is crazy. Like cable TV viewers who really watch only a handful channels, Robbins’ investors would prefer investing in only his best ideas. At the beginning of this year, the five largest positions in Robbins’ portfolio were HCA Holdings Inc (NYSE:HCA), Humana Inc. (NYSE:HUM), Anthem Inc (NYSE:ANTM), Cigna Corporation (NYSE:CI), and Aetna Inc (NYSE:AET).
In this article we will talk about how investors can identify Larry Robbins’ best and worst ideas so that they can generate market beating returns without paying an arm and a leg for these stock picks. By the way, Larry Robbins will be sharing one of his best ideas at this year’s Ira Sohn Conference in New York City.
Investing in only the best ideas of hedge funds should deliver much higher returns on average than investing in ALL (good and bad) ideas of a single hedge fund manager. One of the most successful and richest hedge fund managers of all time is Steve Cohen. Cohen’s SAC Capital managed to return nearly 30% annually over a 20 year period by using a very simple trick. Steve Cohen employed dozens of portfolio managers in his fund. You can think of them as “independent hedge funds” within Cohen’s hedge fund. Portfolio managers are in complete charge of their own funds with the condition that they share their best ideas with Cohen. So, Steve Cohen was really like a hedge fund investor who has the luxury of investing in only the best ideas of more than a dozen hedge funds. This setup helped him beat the market by a huge margin and become one of the richest people on the planet.
Most hedge fund managers including Larry Robbins would rather invest in mediocre ideas instead of concentrated portfolios that contain only their best ideas for two reasons.
First, they manage too much money and it usually isn’t practical to invest billions (and tens of billions of dollars in the case of the largest hedge funds) in only a handful of stocks. There is simply too much interest in hedge funds at the moment. I talked about this issue in detail last month, you can read the details here.
Second, hedge fund managers know that sooner or later even their highest conviction ideas will perform much worse than the market and they may lose most of their investors when this happens. This is what happened to Bill Ackman in 2015 and 2016. At one point Ackman managed almost $20 billion, yet he invested in only about 10 stocks. His Valeant International (VRX) investment turned into a nightmare costing his investors $4 billion. Luckily most of Ackman’s investors aren’t as shallow as the financial journalists who went after him gloating these loses. Ackman survived the huge volume of publicity and still manages more than $10 billion.
We should note that we are still able to identify Ackman’s best and worst ideas in our analysis, but we will reveal the details of that analysis in another article. I am pretty certain that you will be surprised with the performance of Larry Robbins’ best stock picks which we will discuss next.