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Why You Should Dump Your Hedge Funds

Hedge funds are much better investors than you are made to believe by the financial press. Even hedge fund indices hide the truth about hedge funds’ amazing talent in picking winners and losers. Our research has shown that hedge funds’ top small-cap picks outperformed the market by nearly a percentage point per month between 1999 and 2012. We launched an investment newsletter that shares the stock picks of this strategy in real-time. Our best performing hedge funds strategy returned 78.4% between May 2014 and December 3, 2018. S&P 500 ETF (SPY) gained only 60.4% during the same period. On the other hand our battleground short stocks lost 24% since we started sharing them in real time in February 2017, vs. a 22.8% gain for SPY. Hedge funds’ best stock picks significantly outperformed the market, and shorting hedge funds “worst” stock picks generated an outperformance of nearly 47 percentage points in 21 months.

However our advice to you is to dump your hedge funds.

The fact is that most hedge fund investors don’t make as much money as they did in the nineties and the first half of the past decade, where alpha in excess of 10% was the norm. Aggregately speaking, hedge funds’ alpha has been in decline over the past decade for several reasons. They are as follows:

1) A greater level of competition within the hedge fund industry has caused profit margins to shrink.

2) Hedge funds got bigger and started investing in less profitable areas.

3) There are a lot of unskilled hedge fund managers who are trying to get rich by being “lucky”.

4) Equity hedge funds charge an arm and a leg for beta exposure.

Our research has shown that hedge funds have a small edge when it comes to large-cap stock picks and a large edge when it comes to small-cap stock picks. We created a 30-stock portfolio of the most popular large-cap stocks among fund managers. Between 1999 and 2016, this 30-stock portfolio underperformed the market by less than 1 percentage point per year but its annual alpha was 1 percentage point (read the details here).

It should be clear to you, then, that hedge funds’ large-cap stock picks are marginally better than the S&P 500 index because of their lower risk profile. However, if you are a hedge fund client you won’t see much outperformance in this space because you have to surrender 2% of your assets and 20% of each year’s return to your hedge fund manager. If your hedge fund invested entirely in large-cap stocks in 2014, its gross return would have been 13.5% but YOUR net return would have been only 8.8%, because you have to pay 2 percent flat fee and 2.7 percentage points of performance fee as if they accomplished something significant!!

Hedge funds can’t generate enough alpha in the large-cap space to justify their high fees. They invest in the large caps because they have too much money to manage, and they don’t want to give up juicy management fees that enable them buy condos on New York City’s Park Avenue. How do hedge fund managers get away with this?

The answer is simple.

They generate significantly higher alpha in their small-cap stock investments. Generally speaking, there are fewer analysts covering the little guys, and these stocks are less efficiently priced. Hedge funds spend enormous resources to analyze and uncover data about these stocks because this is one of the places where they can generate significant outperformance. Our analysis also shows that this is also a fertile ground for piggyback investors.

Between June 1999 and August 2012, the 15 most popular small-cap stocks among hedge funds managed to return 127 basis points per month.

It is not a typo. Reread it.

This outperformance wasn’t due to high risk either. Our small-cap strategy’s monthly alpha was 81 basis points during this 13-year period (read the details here). This isn’t even the end of the story.

We launched a newsletter at the end of August 2012 that lists the stock picks of this small-cap strategy. During the 2.5 years between September 2012 and February 2015 hedge funds’ most popular small-cap stock picks returned 131.4% vs. 57.2% return for the S&P 500 ETF. This corresponds to an average monthly return of 2.95% for these stocks versus 1.55% for SPY.

Our proposition is very simple: dump your hedge funds and imitate their best small-cap stock picks. You don’t have to surrender 2% of your assets and 20% of your returns. You don’t have to invest in hedge funds’ large-cap picks which usually underperform the market. Finally, you don’t have to worry about fraud/mismanagement and you will have instant access to your funds.

Who are we?

Insider Monkey is one of the fastest growing financial research websites on the web, read by 1.5 million people every month.

Our research is headed by Ian Dogan who is a former fund manager, holding a Ph.D. in the field. We partnered with Marketwatch and created the Marketwatch/Insider Monkey Billionaire Hedge Fund Index.

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Testimonials
  • I've been an Insider Monkey subscriber for a couple years now and the flagship strategy is one of the best strategies in my portfolio. Because the strategy is small cap you will see some major short term swings, but if you can follow the strategy and rebalance only once every quarter you will see some really strong results once you hit the 12 month time frame and beyond.
    David L.
  • I initially became aware of Insider Monkey when Meena was interviewed on Business News Network (BNN) in Canada. The idea of mimicking the best ideas from the best fund managers was appealing (as I have met many smart managers on Bay Street in Toronto). While I have only had the newsletter for one year, the Insider Monkey allocation has been the best performer in my equity portfolio. I look forward to continued outperformance in the future.
    G. Chin
    Toronto, Canada
  • I first came across Insider Monkey (IM) nine quarters ago (1/2013) and since then have enjoyed exceptional returns. Last year (3/2014) I traveled to NYC to meet the founder because I was thinking about doubling down on their strategy. I left favourably impressed and proceeded. It was a smart move. At the beginning of this year I decided to double down again. There are no guarantees but preliminary results are promising.

    Why do I recommend IM?
    1. It's easy: 15 picks every 90 days. Most picks are repeated at least once, some more than eight times.
    2. It's flexible: if a pick goes bad you only hold it for 90 days.
    3. Time saving: the IM team vets hundreds of HF SEC reports every 90 days and produces a list of 15 SC picks from the best stock pickers in the world. A world-class research department for less than a dollar a day.
    4. It works. Need I say more?

    One admonishment: have faith in the model, hold all 15 picks for ninety days.
    Tommy
  • I want to thank you and the team for the great results this past year. Many of my friends and colleagues use profesional financial advisors and annually pay 1% to 1.5% of their portfolio value for mediocre results. Insider Monkey's performance is outstanding for a mere fraction of the cost. I am an analyst for a utility and have always wanted to invest in high growth small cap stocks, but I have never had the time, expertise or access to the information needed to effectively research them, and was never comfortable with casual stock recommendations from magazines, blogs, and television. I had never subscribed to a premium publication but was immediately impressed with the Insider Monkey team’s analysis and the proven results of the 15 Stock Small Cap Strategy.

    Keep up the great work. Thus far, the Insider Monkey team’s approach has enhanced my investment portfolio and I look forward to future issues and following the team’s investment strategy throughout the foreseeable future.
    Jim T.
    New York