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Did Hedge Funds Drop The Ball On Mercer International Inc. (MERC) ?

Reymerlyn Martin

Billionaire hedge fund managers such as David Abrams, Steve Cohen and Stan Druckenmiller can generate millions or even billions of dollars every year by pinning down high-potential small-cap stocks and pouring cash into these candidates. Small-cap stocks are overlooked by most investors, brokerage houses, and financial services hubs, while the unlimited research abilities of the big players within the hedge fund industry can easily identify the undervalued and high-potential stocks that reside the ignored corners of equity markets. There are numerous small-cap stocks that have turned out to be great winners, which is one of the main reasons the Insider Monkey team pays close attention to the hedge fund activity in relation to these stocks.

Mercer International Inc. (NASDAQ:MERC) investors should pay attention to a decrease in enthusiasm from smart money in recent months. Our calculations also showed that MERC 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 32 percentage points since May 2014 through March 12, 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.

Jeffrey Gates Gates Capital

We're going to take a look at the key hedge fund action surrounding Mercer International Inc. (NASDAQ:MERC).

How have hedgies been trading Mercer International Inc. (NASDAQ:MERC)?

At the end of the fourth quarter, a total of 16 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of -16% from one quarter earlier. Below, you can check out the change in hedge fund sentiment towards MERC over the last 14 quarters. With the smart money's positions undergoing their usual ebb and flow, there exists an "upper tier" of noteworthy hedge fund managers who were adding to their holdings substantially (or already accumulated large positions).

MERC_may2019

More specifically, Gates Capital Management was the largest shareholder of Mercer International Inc. (NASDAQ:MERC), with a stake worth $40.4 million reported as of the end of December. Trailing Gates Capital Management was Renaissance Technologies, which amassed a stake valued at $27.3 million. Redwood Capital Management, Knighthead Capital, and Millennium Management were also very fond of the stock, giving the stock large weights in their portfolios.

Since Mercer International Inc. (NASDAQ:MERC) has faced declining sentiment from hedge fund managers, we can see that there lies a certain "tier" of money managers that slashed their positions entirely heading into Q3. Intriguingly, George McCabe's Portolan Capital Management dumped the largest position of the "upper crust" of funds monitored by Insider Monkey, worth an estimated $6.7 million in stock, and Peter Algert and Kevin Coldiron's Algert Coldiron Investors was right behind this move, as the fund sold off about $0.5 million worth. These moves are interesting, as total hedge fund interest was cut by 3 funds heading into Q3.

Let's now take a look at hedge fund activity in other stocks similar to Mercer International Inc. (NASDAQ:MERC). These stocks are CytomX Therapeutics, Inc. (NASDAQ:CTMX), Nine Energy Service, Inc. (NYSE:NINE), SMART Global Holdings, Inc. (NASDAQ:SGH), and Apollo Medical Holdings, Inc. (NASDAQ:AMEH). All of these stocks' market caps are similar to MERC's market cap.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position CTMX,17,123022,-2 NINE,10,38774,3 SGH,14,374016,2 AMEH,3,2024,-1 Average,11,134459,0.5 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 11 hedge funds with bullish positions and the average amount invested in these stocks was $134 million. That figure was $141 million in MERC's case. CytomX Therapeutics, Inc. (NASDAQ:CTMX) is the most popular stock in this table. On the other hand Apollo Medical Holdings, Inc. (NASDAQ:AMEH) is the least popular one with only 3 bullish hedge fund positions. Mercer International Inc. (NASDAQ:MERC) is not the most popular stock in this group but hedge fund interest is still above average. Our calculations showed that top 15 most popular stocks) among hedge funds returned 24.2% through April 22nd and outperformed the S&P 500 ETF (SPY) by more than 7 percentage points. Hedge funds were also right about betting on MERC as the stock returned 35.1% and outperformed the market by an even larger margin. Hedge funds were rewarded for their relative bullishness.

Disclosure: None. This article was originally published at Insider Monkey.

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