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Top 5 Hedge Fund Stocks Absolutely Crushed The Market

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Inan Dogan, PhD
·5 min read
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How many times in the last decade have you heard that active stock picking is dead? Even the legendary billionaire investor Warren Buffett lectured investors about the "wisdom" of investing in index funds. Last month, when the S&P 500 Index plunged nearly 30% in a matter of weeks, I bet your financial advisor told you to stay the course and not sell.

Do you know what we did? We told our investors that a recession is coming and short the market to protect their portfolios at the end of February. After the stock market bottomed, when Wall Street analysts were telling everybody that "recent lows will be retested, we told our subscribers to cover their shorts and buy, buy, buy.

Before this coronavirus bear market, when the S&P 500 Index was riding high, I came across countless articles about how hedge funds as a group underperforming the market. Those financial journalists are idiots. Hedge funds aren't magicians. It is very difficult to beat the S&P 500 Index that is running high on steroids (that's what I call the 2019's Fed induced stock rally) with a portfolio that is only 50% long (or %50 hedged). During the first quarter of 2020, S&P 500 Index lost 19.4% and hedge funds beat it by a huge margin. Guess what the same journalists said this time? Nope, they didn't praise hedge funds for beating the market, they criticized them for delivering negative returns.

Here is an objective analysis of hedge funds. Hedge funds are good at stock picking, but they couldn't beat the market in 2019 for two simple reasons. First, they are hedged. Their net beta exposure is around 50%. So, they can only return about half the return of the market. Second, they charge an arm and a leg for their services. Investors didn't mind paying 2% of their capital and 20% of their returns as fees when hedge funds were returning 30% per year in the 90s. However, this fee structure is ridiculous in today's market. There are only a few hedge fund managers who deserve this kind of compensation scheme. One of them is Michael Castor. When the S&P 500 lost nearly 20% in Q1, Castor's Sio Capital returned more than 7% after fees. You can watch our latest video about his coronavirus analysis below:

Hedge funds as a group charge too much for their stock picking services. Fortunately, there is a work around. You don't have to pay hedge funds an arm and a leg for their stock picking skills. Once a quarter, all large US equity hedge funds have to disclose their portfolio holdings in US public equities in 13F filings. We get to see which stocks they bought, sold, and how many shares of each stock they hold in their portfolios. This is very valuable data.

Insider Monkey tracks more than 1000 hedge funds. Since the end of 2018 we have been reporting the names of top 30 hedge fund stocks every quarter like clock work.

Now, I am going to share some return numbers that you are going to find hard to believe. That's understandable. Even uncle Warren Buffett has been telling you to stick with low cost S&P 500 Index funds, and journalists have been bashing hedge funds left and right, so you wouldn't expect hedge funds outperform the market. That's just crazy, right?

Here are the numbers. S&P 500 Index ETF (SPY) returned 5.7% since the end of 2018. Not too shabby given that we are in the middle of a recession. So, if you listened to Warren Buffett and invested $10000 in SPY, you would have made $570 in 5 quarters.

The top 5 stocks among hedge funds returned 30.2% since the end of 2018. If you subscribed to Insider Monkey's free email alerts and invested $10000 in hedge funds' top 5 stocks, you would have made $3020. Ask yourself why Warren Buffett isn't investing Berkshire's $100+ billion cash in index funds, and instead hired two former hedge fund managers to succeed him.

The top 5 hedge fund stocks also outperformed the S&P 500 ETFs by 12.5 percentage points this year and 8.6 percentage points last year. Basically, hedge funds' top consensus picks were able to beat the market in up and down markets.

You can check out the entire list of top 30 hedge fund stocks here. It isn't like these stocks change much from quarter to quarter. The top 5 stocks at the end of 2019 were Amazon.com Inc. (NASDAQ:AMZN), Facebook Inc. (NASDAQ:FB), Microsoft Corp (NASDAQ:MSFT), Alibaba Group Holding Limited (NYSE:BABA), and Alphabet Inc (NASDAQ:GOOGL).

Guess which 5 stocks were hedge funds' top picks at the end of September? You are right, the same 5 stocks. During the fourth quarter, hedge funds bought more of Amazon.com Inc (AMZN) and made it their number 1 pick. Amazon ranked 2nd at the end of September and Facebook ranked #1.

Guess which 5 stocks were hedge funds' top picks at the end of June? You are right again, the same 5 stocks. As you can see, hedge funds' top 5 picks don't change much from quarter to quarter, and they outperformed the market by a cumulative ~25 percentage points over the last 5 quarters.

Disclosure: No positions in these 5 stocks because I search for even more promising stocks than these top 5 hedge fund stocks and recommend them in Insider Monkey's premium newsletters. I have a long position in SPY which I bought in 2009 and don't want to sell because of capital gains tax. This article is originally published at Insider Monkey.