Hedge funds are known to underperform the bull markets but that's not because they are terrible at stock picking. Hedge funds underperform because their net exposure in only 40-70% and they charge exorbitant fees. No one knows what the future holds and how market participants will react to the bountiful news that floods in each day. However, hedge funds' consensus picks on average deliver market beating returns. For example in the first 5 months of this year through May 30th the Standard and Poor’s 500 Index returned approximately 12.1% (including dividend payments). Conversely, hedge funds’ top 20 large-cap stock picks generated a return of 18.7% during the same 5-month period, with the majority of these stock picks outperforming the broader market benchmark. Interestingly, an average long/short hedge fund returned only a fraction of this value due to the hedges they implemented and the large fees they charged. If you pay attention to the actual hedge fund returns versus the returns of their long stock picks, you might believe that it is a waste of time to analyze hedge funds' purchases. We know better. That's why we scrutinize hedge fund sentiment before we invest in a stock like Caterpillar Inc. (NYSE:CAT).
Caterpillar Inc. (NYSE:CAT) investors should pay attention to a decrease in activity from the world's largest hedge funds lately. Our calculations also showed that CAT isn't among the 30 most popular stocks among hedge funds.
So, why do we pay attention to hedge fund sentiment before making any investment decisions? Our research has shown that hedge funds' small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the market by 40 percentage points since May 2014 through May 30, 2019 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter. Even if you aren't comfortable with shorting stocks, you should at least avoid initiating long positions in our short portfolio.
We're going to take a peek at the new hedge fund action surrounding Caterpillar Inc. (NYSE:CAT).
How are hedge funds trading Caterpillar Inc. (NYSE:CAT)?
At Q1's end, a total of 53 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -12% from the previous quarter. On the other hand, there were a total of 53 hedge funds with a bullish position in CAT a year ago. With the smart money's positions undergoing their usual ebb and flow, there exists an "upper tier" of noteworthy hedge fund managers who were boosting their stakes substantially (or already accumulated large positions).
According to Insider Monkey's hedge fund database, Bill & Melinda Gates Foundation Trust, managed by Michael Larson, holds the biggest position in Caterpillar Inc. (NYSE:CAT). Bill & Melinda Gates Foundation Trust has a $1.5257 billion position in the stock, comprising 7.3% of its 13F portfolio. Coming in second is Citadel Investment Group, led by Ken Griffin, holding a $326.3 million position; the fund has 0.2% of its 13F portfolio invested in the stock. Other members of the smart money that hold long positions encompass D. E. Shaw's D E Shaw, Jim Simons's Renaissance Technologies and Robert Bishop's Impala Asset Management.
Since Caterpillar Inc. (NYSE:CAT) has witnessed declining sentiment from the entirety of the hedge funds we track, logic holds that there was a specific group of fund managers who were dropping their entire stakes last quarter. At the top of the heap, Matt Simon (Citadel)'s Ashler Capital said goodbye to the biggest position of the 700 funds watched by Insider Monkey, totaling an estimated $101.3 million in stock, and Brandon Haley's Holocene Advisors was right behind this move, as the fund said goodbye to about $95.3 million worth. These bearish behaviors are interesting, as aggregate hedge fund interest dropped by 7 funds last quarter.
Let's now review hedge fund activity in other stocks similar to Caterpillar Inc. (NYSE:CAT). We will take a look at Bristol Myers Squibb Company (NYSE:BMY), U.S. Bancorp (NYSE:USB), China Life Insurance Company Ltd. (NYSE:LFC), and ConocoPhillips (NYSE:COP). This group of stocks' market values are similar to CAT's market value.
[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position BMY,71,4098599,13 USB,44,6941152,3 LFC,7,38797,0 COP,54,2718979,-5 Average,44,3449382,2.75 [/table]
View table here if you experience formatting issues.
As you can see these stocks had an average of 44 hedge funds with bullish positions and the average amount invested in these stocks was $3449 million. That figure was $3394 million in CAT's case. Bristol Myers Squibb Company (NYSE:BMY) is the most popular stock in this table. On the other hand China Life Insurance Company Ltd. (NYSE:LFC) is the least popular one with only 7 bullish hedge fund positions. Caterpillar Inc. (NYSE:CAT) is not the most popular stock in this group but hedge fund interest is still above average. This is a slightly positive signal but we'd rather spend our time researching stocks that hedge funds are piling on. Our calculations showed that top 20 most popular stocks among hedge funds returned 1.9% in Q2 through May 30th and outperformed the S&P 500 ETF (SPY) by more than 3 percentage points. Unfortunately CAT wasn't nearly as popular as these 20 stocks and hedge funds that were betting on CAT were disappointed as the stock returned -9.5% during the same period and underperformed the market. If you are interested in investing in large cap stocks with huge upside potential, you should check out the top 20 most popular stocks among hedge funds as 13 of these stocks already outperformed the market so far in Q2.
Disclosure: None. This article was originally published at Insider Monkey.