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 Alarm.com Holdings, Inc. (NASDAQ:ALRM).
Is Alarm.com Holdings, Inc. (NASDAQ:ALRM) the right investment to pursue these days? The best stock pickers are buying. The number of bullish hedge fund positions increased by 1 lately. Our calculations also showed that alrm 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.
Let's take a look at the key hedge fund action regarding Alarm.com Holdings, Inc. (NASDAQ:ALRM).
What does smart money think about Alarm.com Holdings, Inc. (NASDAQ:ALRM)?
At Q1's end, a total of 16 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of 7% from one quarter earlier. On the other hand, there were a total of 17 hedge funds with a bullish position in ALRM a year ago. With the smart money's positions undergoing their usual ebb and flow, there exists an "upper tier" of key hedge fund managers who were increasing their holdings meaningfully (or already accumulated large positions).
More specifically, Bares Capital Management was the largest shareholder of Alarm.com Holdings, Inc. (NASDAQ:ALRM), with a stake worth $94.8 million reported as of the end of March. Trailing Bares Capital Management was Akre Capital Management, which amassed a stake valued at $39 million. Renaissance Technologies, Arrowstreet Capital, and Greenvale Capital were also very fond of the stock, giving the stock large weights in their portfolios.
Now, specific money managers were breaking ground themselves. Renaissance Technologies, managed by Jim Simons, initiated the largest position in Alarm.com Holdings, Inc. (NASDAQ:ALRM). Renaissance Technologies had $19.5 million invested in the company at the end of the quarter. Peter Rathjens, Bruce Clarke and John Campbell's Arrowstreet Capital also made a $17.4 million investment in the stock during the quarter. The other funds with brand new ALRM positions are Joel Greenblatt's Gotham Asset Management, Noam Gottesman's GLG Partners, and John Overdeck and David Siegel's Two Sigma Advisors.
Let's also examine hedge fund activity in other stocks similar to Alarm.com Holdings, Inc. (NASDAQ:ALRM). These stocks are Domtar Corporation (NYSE:UFS), Mercury Systems Inc (NASDAQ:MRCY), FirstService Corporation (NASDAQ:FSV), and Gold Fields Limited (NYSE:GFI). This group of stocks' market values are similar to ALRM's market value.
[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position UFS,19,178842,-6 MRCY,15,58014,9 FSV,11,144724,-2 GFI,10,208835,1 Average,13.75,147604,0.5 [/table]
View table here if you experience formatting issues.
As you can see these stocks had an average of 13.75 hedge funds with bullish positions and the average amount invested in these stocks was $148 million. That figure was $219 million in ALRM's case. Domtar Corporation (NYSE:UFS) is the most popular stock in this table. On the other hand Gold Fields Limited (NYSE:GFI) is the least popular one with only 10 bullish hedge fund positions. Alarm.com Holdings, Inc. (NASDAQ:ALRM) 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 6.2% in Q2 through June 19th and outperformed the S&P 500 ETF (SPY) by nearly 3 percentage points. Unfortunately ALRM wasn't nearly as popular as these 20 stocks and hedge funds that were betting on ALRM were disappointed as the stock returned -16.1% 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.