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Is Studying What Hedge Funds Bought Last Quarter Helpful?

There is a whole industry dedicated to studying hedge funds’ past purchases in an attempt to extract some alpha. Once a quarter, all institutional investors with over $100mm under management are required to report their long positions – the so called Form 13F is filed within 45 days of the end of a calendar quarter. Basically, 13F is a look at what hedge funds bought and sold 45 days or more ago.

This morning, I was going through Josh Brown’s links and clicked on a piece from FactSet, covering hedge funds’ moves from Q3. I saw that the two largest individual stock additions in that quarter were Facebook ($FB) and Baidu ($BIDU) and tweeted the following:

ivanhoff

Nov. 22 at 9:28 AM

Reading about what hedge funds bought last quarter has mainly educational value. Price actions tells you what they do in real time.

We certainly did not need to wait a few months to figure out that $FB and $BIDU were under heavy accumulation during the summer. Price action on those names told use everything we had to know, in real time.

Don’t get me wrong – there are many strategies that try to piggy-back some of the famous money managers positions. Some are doing an exceptional job by copying and following. From my perspective, 13Fs have more educational than actionable value. 13Fs could help you figure out how investors think and when they buy and sell. In the case of $FB and $BIDU in Q3, there are three main observations that could be made:

1) Buying highly shorted stocks after they crush earnings estimates and gap to new all-time highs.

2) Pay attention to industry relative strength – anything related to social media and internet was melting hot during the summer.

3) When institutions buy, they leave traces. They don’t do all their buying in one day, therefore there’s plenty of time for anyone who is watchful enough to jump back with them in real time.

A minute after my tweet, my friend Frank Zorrilla (@zortrades) reminded me that there’s an ETF ($GURU) that buys what select hedge funds bought last quarter and it has been delivering some solid alpha since inception. Look at the chart below

How is that outperformance possible when the media has constantly bombarded us with proves that cumulatively, hedge funds have not really generated any alpha after fees over the past decade? How is it possible for an ETF that buys weeks and months after the tracked hedge funds bought, to outperform the S&P 500. I have no idea what the actual performance of the tracked hedge funds is, but here’s why this ETF might have done so well lately.

1) it tracks mainly hedge funds, which average holding period is more than a year

2) it charges relatively smaller fee of 75bps. Hedge funds charge 2% and 20%. This is a huge difference. If a hedge fund makes 40% pre-fees, after 2/20 its return will be a little less than 30%.

Take into account that this ETF is relatively young and has only operated in a scorching hot bull market. Typically, the success rate of all market strategies is cyclical.

98 Stocks Went Up Over 1000% In The Past 5 Years

In the Fall of 2008, equity markets were falling apart. Well, the world did not end and 5 years later there are 98 stocks that gained more than 1000%.

Here are the top 10 performers of the past 5 years: biotech and old-media stocks have the most members in top 10. The former, because the market has not idea how to really price them. The latter, because in 2008, they were priced for bankruptcy and it did not happen.

$PCYC +8700%
$JAZZ +7450%
$KERX +6085%
$STRZA +5938%
$NXST +5116%
$RPTP +4864%
$GTN +4684%
$HGSH +4678%
$GENT +4570%
$ATSG +4431%

Study carefully the list of 98. You will notice that they did not become ten-baggers overnight. People like to say that past performance does not guarantee future returns. It is true. It does not guarantee them, but it could help you improve the odds of finding the next big winners. Look at $PCYC for example. It has more than doubled for 3 years in a row.

Here’s the thing about momentum. Stocks that outperformed in the past 3 to 18 months, tend to outperform in the next 3 to 18 months. Longer-term momentum (3-10 years) often leads to mean-reversion.

Did Twitter IPO Leave Too Much Money On The Table?

Every time a popular tech name doubles on the first day it is publicly traded, journalists write articles about how it left too much money on the table. Today it was no different with Twitter, so I tweeted the following.

ivanhoff

Nov. 7 at 1:07 PM

The myopic dummies that say that $TWTR IPO left too much money on the table, have no idea how financial markets work.

I received several requests to elaborate on my words, so here it is.

Twitter sold 70mm shares at $26 and raised $1.8bn. Just because the price opened at 45 and closed there, some assume that Twitter left money on the table and should’ve raised the price. Non-sense.

First, you have to remember that IPOs are means to an exit strategy. Every private company is owned by its founders, management, employees and VCs. Before a company goes public, its Board of Directors issues shares to the entity (in this case Twitter Inc.). Most of entity’s shares are offered to the public via an IPO. The rest of the shares are owned by the mentioned insiders, but they are restricted to sell them in the next 6 to 12 months after the IPO.

Twitter sold 70mm shares out of 575mm shares outstanding, which means that its current float (number of shares available to trade) is 70mm shares. Its restricted shares (owned by Twitter’s insiders) are 505mm and they will become available to trade within the next year.

There is a reason only a small percentage of each new public company’s shares outstanding is offered – to limit the supply in order to maximize the market valuation of that company. Do you really think that Twitter would’ve got $26 a share if it sold 500mm shares?

Investment banks do a serious research in order to figure out the demand. It is often an educated guess based on extensive experience of underwriting IPOs. They have two clients – the private owners of company that is going public (usually one-time customers) and institutions that buy the IPO allocations (repeat customers). Guess which interests they are trying to cater to more?

What would’ve happened if Twitter raised its IPO price to $40? First of all, the odds are that at $40 it would have been under-subscribed or it would have become a second “Facebook”. We all remember Facebook’s fiasco from May 2012, which basically closed the doors for new IPO deals for months to come. Facebook raised a little bit more money, but as a result everyone suffered. Retail investors and institutions were burned, investment banks lost business, employees were able to sell at a lot lower prices 6 months later as Facebook’s stock was crushed.

When a stock performs outstanding in the months after its IPO, it provides a huge window of opportunity for secondary offerings – where in most cases, insiders sell their restricted shares ahead of schedule. This is their exit, this is their pay-day.

Institutions are lot more willing to buy the secondaries of stocks that gained after their IPO. Secondaries are often a necessary evil. They are organized transfers of ownership that helps to smooth out insider selling that will happen anyway.

Lastly, for the IPO market to continue to work in long-term perspective and deliver the current absorbitant valuations, you have to leave some meat on the bones for the public. Nowadays, most of the wealth is created for the founders, VCs and early employees. Companies go public a lot later in their growth cycle, when they already have serious international exposure and as a result demand higher valuation.