Hedge funds and other investment firms that we track manage billions of dollars of their wealthy clients' money, and needless to say, they are painstakingly thorough when analyzing where to invest this money, as their own wealth also depends on it. Regardless of the various methods used by elite investors like David Tepper and David Abrams, the resources they expend are second-to-none. This is especially valuable when it comes to small-cap stocks, which is where they generate their strongest outperformance, as their resources give them a huge edge when it comes to studying these stocks compared to the average investor, which is why we intently follow their activity in the small-cap space. Nevertheless, it is also possible to identify cheap large cap stocks by following the footsteps of best performing hedge funds.
Kansas City Southern (NYSE:KSU) shares haven't seen a lot of action during the second quarter. Overall, hedge fund sentiment was unchanged. The stock was in 26 hedge funds' portfolios at the end of June. The level and the change in hedge fund popularity aren't the only variables you need to analyze to decipher hedge funds' perspectives. A stock may witness a boost in popularity but it may still be less popular than similarly priced stocks. That's why at the end of this article we will examine companies such as Vornado Realty Trust (NYSE:VNO), Elanco Animal Health Incorporated (NYSE:ELAN), and Ally Financial Inc (NYSE:ALLY) to gather more data points. Our calculations also showed that KSU isn't among the 30 most popular stocks among hedge funds (view the video below). Video: Click the image to watch our video about the top 5 most popular hedge fund stocks.
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.
Unlike some fund managers who are betting on Dow reaching 40000 in a year, our long-short investment strategy doesn't rely on bull markets to deliver double digit returns. We only rely on hedge fund buy/sell signals. We're going to take a peek at the latest hedge fund action regarding Kansas City Southern (NYSE:KSU).
What does smart money think about Kansas City Southern (NYSE:KSU)?
Heading into the third quarter of 2019, a total of 26 of the hedge funds tracked by Insider Monkey were bullish on this stock, a change of 0% from the first quarter of 2019. By comparison, 26 hedge funds held shares or bullish call options in KSU a year ago. With the smart money's capital changing hands, there exists an "upper tier" of noteworthy hedge fund managers who were adding to their stakes substantially (or already accumulated large positions).
Of the funds tracked by Insider Monkey, Winton Capital Management, managed by David Harding, holds the biggest position in Kansas City Southern (NYSE:KSU). Winton Capital Management has a $38.9 million position in the stock, comprising 0.8% of its 13F portfolio. Sitting at the No. 2 spot is AQR Capital Management, managed by Cliff Asness, which holds a $35 million position; the fund has less than 0.1%% of its 13F portfolio invested in the stock. Some other professional money managers with similar optimism encompass Gregg Moskowitz's Interval Partners, Ken Fisher's Fisher Asset Management and Jorge Paulo Lemann's 3G Capital.
Seeing as Kansas City Southern (NYSE:KSU) has experienced bearish sentiment from the entirety of the hedge funds we track, it's safe to say that there is a sect of hedge funds that slashed their positions entirely last quarter. At the top of the heap, Jonathan Barrett and Paul Segal's Luminus Management dropped the biggest investment of the 750 funds tracked by Insider Monkey, comprising an estimated $92.2 million in call options. Brandon Haley's fund, Holocene Advisors, also dropped its call options, about $48.7 million worth. These transactions are important to note, as aggregate hedge fund interest stayed the same (this is a bearish signal in our experience).
Let's now take a look at hedge fund activity in other stocks - not necessarily in the same industry as Kansas City Southern (NYSE:KSU) but similarly valued. We will take a look at Vornado Realty Trust (NYSE:VNO), Elanco Animal Health Incorporated (NYSE:ELAN), Ally Financial Inc (NYSE:ALLY), and The Liberty SiriusXM Group (NASDAQ:LSXMK). All of these stocks' market caps match KSU's market cap.
[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position VNO,27,534294,-3 ELAN,27,520304,-6 ALLY,43,2105450,8 LSXMK,42,2588588,-3 Average,34.75,1437159,-1 [/table]
View table here if you experience formatting issues.
As you can see these stocks had an average of 34.75 hedge funds with bullish positions and the average amount invested in these stocks was $1437 million. That figure was $371 million in KSU's case. Ally Financial Inc (NYSE:ALLY) is the most popular stock in this table. On the other hand Vornado Realty Trust (NYSE:VNO) is the least popular one with only 27 bullish hedge fund positions. Compared to these stocks Kansas City Southern (NYSE:KSU) is even less popular than VNO. Hedge funds clearly dropped the ball on KSU as the stock delivered strong returns, though hedge funds' consensus picks still generated respectable returns. Our calculations showed that top 20 most popular stocks among hedge funds returned 24.4% in 2019 through September 30th and outperformed the S&P 500 ETF (SPY) by 4 percentage points. A small number of hedge funds were also right about betting on KSU as the stock returned 9.5% during the third quarter and outperformed the market by an even larger margin.
Disclosure: None. This article was originally published at Insider Monkey.