16 Most Favored Stocks By Institutional Investors And Hedge Fund Managers

Institutional investors must know it better. That's a rule I often hear from friends but why should this be true? Maybe they are better informed because the shake hands with CEO's or politicians.

The second issue is that hedge fund managers have enough firepower to move the stock price in any direction.

However, don't think about why they are trading and let us look at the most favored stocks from big investor gurus.

Attached is the full list of the 16 most loved stocks. Do you like some of them?

These are the highest yielding results in detail...

Did Social Media Predict Carl Icahn’s Biggest Trades?

The following article was written by our guest author Insider Monkey. There are a select few money managers whose words can move entire markets, but up to this point, only one has mastered the medium of Twitter [TWTR]: Carl Icahn. After creating an account earlier this year, the billionaire has disclosed a few big positions on the micro blogging site, including a purchase of Apple [AAPL] and a sale of Netflix [NFLX] stock.

While the media has had a lot to say about Icahn’s Twitter account, no one has taken the time to examine his trades in terms of social media sentiment. For someone who is likely the world’s most socially active hedge fund manager, surprisingly little analysis has been done in this realm.

With the help of Market Prophit, a company that converts stock-related social media posts into easy-to-read data, we’re able to look at how much chatter Icahn’s biggest trades created. More interestingly, it appears that some of this buzz actually predicted the moves before they happened.

Netflix

Netflix was the recipient of a major cut by Icahn late last month. In a 13D filing and subsequent tweet after the market’s close on October 22nd, the investor reported a 4.5% stake in the streaming video company, about half of what he previously owned. This move came 24 hours after Netflix’s stock price had surged on promising third quarter earnings.

Market Prophit’s CEO, Igor Gonta, revealed to us that on the morning of the 22nd, social media circles were already buzzing about a major seller “doing large block sales” of Netflix, and Icahn’s name was visibly in the rumor mill. By the time the market had closed, Icahn’s official SEC disclosure pressed the stock to drop almost all of its gains from the previous day’s earnings report.

Apple

Any analysis of Carl Icahn and Twitter must include Apple. On the afternoon of August 13th this year, Icahn tweeted that he had a “large position” in the tech giant on the basis of undervaluation, adding that a conversation with Tim Cook was on the table. As Gonta pointed out to us, shares of Apple rallied by nearly 2.5% just 20 minutes after Icahn’s initial tweet, and social media sentiment turned positive approximately two minutes prior to the reveal (see graph here).

The next major event on the Icahn-Apple timeline was on October 1st. Halfway through the morning on this date, Icahn tweeted about the dinner he had with Tim Cook the night before, in which he reiterated his desire for Apple to pursue a $150 billion share buyback plan.

Market Prophit again picked up on bullish chatter before Icahn’s tweet went live at 10:23am. This time, an uptick in positive social chatter led the tweet by a full 40 minutes, and shares of Apple had already risen by almost one full percentage point by half past ten. According to Gonta, social media sentiment turned negative immediately following Icahn’s tweet “because the price had already run up,” indicating that a classic “sell the news” phenomenon had just taken place.

Sitting here in early November, it’s unknown if Icahn will succeed in his quest to convince Apple that a larger buyback will lead to a $1,250 stock price. What we can say with confidence, though, is if the hedge fund manager is active on Twitter again, social media chatter may predict it.

Disclosure: none

How George Soros Plays The Stock Market

The following article was written by our guest author Insider Monkey. Opinions of George Soros vary depending on whom you ask, but there’s no arguing against the Hungarian-American hedge fund manager’s investing pedigree. Earlier this month, Soros shared his thoughts on the Eurozone crisis at the Global Economic Symposium, and most of the usual headlines that surround the billionaire are focused on his macroeconomic views.

That’s all fine and dandy. We’d like to point out, though, that George Soros’ Soros Fund Management does maintain a $9 billion equity portfolio too. Due to the market-beating potential of hedge funds’ best stock picks (discover how we returned 47.6% in our first year), it’s useful to understand how a prominent investor like Soros is playing the stock market.

At the end of last quarter, George Soros and his management team disclosed a little over 200-equity holdings, with 15% of their capital allocated to their top five stock picks. This level of concentration is not uncommon for a large hedge fund, but a few of the specific names may surprise you.

Google

Other than Google [GOOG], that is. It’s really not very difficult to understand why the tech company is Soros’ No. 1 stock. Google was hedge funds’ favorite pick in the latest round of 13F filings, ahead of AIG [AIG] and Apple [AAPL]. Aside from offering a bevy of long-term product innovations like self-driving cars or smart thermostats, more immediate catalysts are the launch of the Moto X and next year’s release of Google Glass.

Both devices play into Wall Street’s bullish earnings estimates for Google, in which it expects 17% to 18% EPS growth in 2014 and 15% annual growth over the next half-decade. This trumps peers like Yahoo [s:YHOO] and even Apple. In addition to Soros’ bullishness, big-name fund managers Ray Dalio and Israel Englander have initiated Google positions in the last few months.

J.C. Penney

This is what we meant when we said you might be surprised. J.C. Penney [JCP] represents everything Google does not: poor market performance in 2013, high CEO turnover, an inconsistent business plan, and an uncertain future. The retailer is going back to its pre-Ron Johnson coupon strategy, which leads some to believe that it can recapture most of its old customers, and is thus undervalued at current levels.

It’s easier to be skeptical of this move than it is to support a bullish thesis, so we have a rare case where Soros is acting as a contrarian by betting on a stock rather than against it. Assuming you are for a turnaround here, J.C. Penney trades at a mere 0.15 times sales, but earnings will have to pick up. Longs can’t take many more monumental bottom line whiffs. Last quarter the retailer missed sell-side estimates by 88%, and in the first quarter of the year, EPS fell short of consensus by 36%. In fact, J.C. Penney has been in the red for a year and a half now.

A few days ago, Richard Perry cut almost half of his position in the retailer and last month, Bill Ackman liquidated his entire stake. What’s so notable about both of these moves is that Ackman’s hedge fund had the largest stake in J.C. Penney at the end of last quarter while Perry was third.

The remaining three

After the antithetical duo of Google and J.C. Penney, Soros’ next largest holdings are Herbalife [HLF], Charter Communications [CHTR] and Johnson & Johnson [JNJ].

While Ackman and Carl Icahn continue to feud about the legitimacy of Herbalife’s marketing practices, George Soros continues to book gains. Since we know that he held shares of the company on the last day of June, it can be inferred that Soros has made at least a 51% return on his long position. If he initiated the stake earlier in the second quarter, like in early May for example, this return stretches to more than 70%. Either way, the billionaire has to be happy that it represents one of his biggest holdings.

Charter Communications, meanwhile, is another stock that is up big (+72%) in 2013. The cable entertainment company has been a long-term pick for Soros, sitting in his clutches since early 2011. The same can be said for Johnson & Johnson, which has been in Soros’ equity portfolio for exactly four quarters. Johnson & Johnson is a prototypical dividend-payer that has actually offered double-digit capital gains this year, while Charter is a growth play plain and simple.

All in all, the variety presented in George Soros’ five largest stock picks is truly one of the best things about this group. Google, J.C. Penney and Herbalife are the three we’ll watch the closest going forward, particularly when new 13F filings come in mid-November.

Disclosure: none

100 Most Bought Stocks By Investment Gurus

100 most bought stocks by investment professionals originally published on Dividend Yield – Stock, Capital, Investment. I love it to see how the big investors act on the market. Some of them have a really interesting and creative investing strategy which works only with huge amounts of capital.

Some hedge funds play with money and try to boost its return by ignoring a good diversification. But if they know the business and management team the risk might be lower as for desk research investors like us.

However, each month I publish a little list about the largest stock buys from 49 super investors. I analyze how often a stock was bought over the recent six months and ranked them in my 100 best guru buy list. All super gurus combined bought 655 stocks within the recent half year.

In my view, it’s a good tool to look at the activities of guru investors in the market because they have big money in their pockets and if they invest combined, they could change the market very easily.

Their attitude to stocks is also lightning the way to return, not always but sometimes because the media notices the portfolio changes of the hedge fund managers and create additional publicity.

Technology is still the place to be for the investment guru’s. I think that they have noticed the huge cash reserves of Apple and the other stocks. Not enough, most of them are very profitable and grow further despite they don’t have new technologies developed.

Carl Icahn’s Best Pick Isn’t Apple…These Stocks Are! - How The Big Investor Makes Money

The following article was written by our guest author Insider Moneky. Carl Icahn may have lifted the company’s market cap by $20 billion in less than two days of trading last month, but Apple [s:AAPL] isn’t his best stock pick. There are four positions in the multi-billionaire’s equity portfolio that are worth looking at before Cupertino. We’ll show you which ones and explain why.

At the end of last quarter, Carl Icahn’s hedge fund held long positions in 19 different companies totaling a market value of $21.5 billion. With Icahn’s pedigree as an elite activist investor, it’s not surprising that he’d have that much money in U.S. equities, but it is a bit intriguing that four of his eleven largest picks are small-caps.

According to our research at Insider Monkey, hedge funds’ small-cap picks have the highest potential to outperform the market over a sustained period of time. Our premium newsletter, which employs this strategy, beat the S&P 500 by nearly 30 percentage points in its first year (discover how we did this here).

With that in mind, let’s run through the four largest small-cap investments in Icahn’s equity portfolio. Each stock had a market cap between $1 billion and $5 billion at the end of the last 13F-filing period.

CVR Energy [CVI] is Icahn’s largest small-cap holding, and his stake comprises more than four-fifths of its outstanding shares. After grabbing exposure in CVR Energy last year, Icahn’s initial goal was to push for a sale of the company to a larger buyer. Once this move failed, he then guided CVR to spin off its refining subsidiary in January. In his last filing, Icahn held $3.6 billion in CVR Energy stock and $138 million in the spinoff, CVR Refining [CVRR].

The latter has returned just 0.2% post-IPO, but CVR Energy shares are up almost 70% since Icahn first established his stake in early 2012. The bet has been very profitable for Icahn, and with gushing refining margins in its last few earnings reports, there may be more appreciation on the horizon for CVR Energy.

Federal Mogul [FDML], meanwhile, is another high-flier in Icahn’s equity portfolio. The hedge fund manager’s second largest small-cap holding has been a key investment since 2011. In the summer of that year, Icahn established his original position in the auto part maker, and he has held a controlling interest ever since. Shares of Federal Mogul are up a whopping 177% in the past six months on the back of a massive earnings beat last quarter and a fairly extensive restructuring program.

Herbalife [HLF] needs no introduction, and is the next largest-small cap in Icahn’s portfolio. The multi-level marketer had a market cap below $5 billion at the end of last quarter, but its value has since risen by about 50%. Over the longer term, Herbalife shares have more than doubled since the start of 2013, and the market hasn’t been convinced by Bill Ackman’s “pyramid scheme” accusations (see his full presentation here).

Icahn has shown no hesitation to call out Pershing Square’s manager for being “totally wrong” and “ridiculous” in his words, but Ackman hasn’t shown any signs of closing his short position in Herbalife. As for Icahn, he thinks the stock is still cheap at current levels.

Hain Celestial Group [HAIN] is the next largest small-cap in the activist’s equity portfolio, and surprise, surprise, this stock is having a good 2013 too. Shares of the organic food and personal care product company are up 37% this year, and Icahn closed out his $470 million position a little over two weeks ago. Since he established his Hain stake in early 2010, the stock’s price has risen from around $22 per share to the upper $70 range.

As CEO Irwin Simon explains in a recent interview with CNBC, “Hain today is positioned better than it was when Carl got in … because of the awareness of healthy eating.” In other words, it’s the secular tailwinds—not just Icahn’s influence on a couple M&A moves—that have driven Hain’s appreciation. The organic boom doesn’t look like it will end any time soon according to the USDA, so we still like Hain Celestial post-Icahn.

Disclosure: none

Bruce Berkowitz’s Latest Stock Buys And His Full Portfolio Holdings

Bruce Berkowitz’s Fund Portfolio Strategies originally published at long-term-investments.blogspot.com. Bruce Berkowitz is also a well known guru investor. He is a hedge fund manager who cares about $7.69 billion in his asset management vehicle Fairholme Capital Management.

Within the recent quarter, Bruce made nine asset transactions of which six pay dividends. Four of the stock moves are attributable to the long side and five are on the short side.

In total, Bruce owns now only 13 share positions of which two were completely new (Lincoln National and Hartford Financial). In addition, he sold-out three stocks within the recent quarter. 

Financial stocks dominate his asset strategy. Around 68 percent of his total assets have a relationship to the financial sector.

The biggest position is his portfolio is reasonable to the insurer, AIG who represents around 50 percent of his full portfolio.

Nothing changed much in sum. Bruce made no big changes within the recent quarter. The highest trade impact on the long side had the 4.53 percent position increase of Sears Holdings.

Is An ‘Activist Mutual Fund’ A Smart Investment?

The following article was written by our guest author Insider Monkey. At Insider Monkey, we use a number of techniques to track investment activity of hedge funds and other notable investors. Our research has shown that the most popular small cap stocks among hedge funds, as determined by quarterly 13F filings, earn an average excess return of 18 percentage points per year (discover the details of our small-cap strategy). Last summer, we put this theory into practice by publishing a portfolio of the most popular small caps and since inception this portfolio has beaten the S&P 500 by 29 percentage points.

The activist

Investors can also receive more up-to-date information about what hedge fund managers are doing through 13D and 13G filings. 13Ds are also known as activist filings—when a hedge fund such as billionaire Carl Icahn’s Icahn Capital or billionaire Bill Ackman’s Pershing Square files a 13D as opposed to a 13G, it usually signals that it intends to push management to make changes at the company either privately or publicly. While activist campaigns do not always work, often these managers are successful in getting a company to sell itself, spin out a non-core business unit, return more cash to shareholders, or take other actions that increase shareholder value.

They also may benefit from improvements in general market conditions that push up the stock price, as with any other hedge fund investment. The combination of these factors sometimes results in high average returns: Icahn, for example, tends to have done well with his 13D filings in the past couple of years.

Meet one 13D Activist Fund

Northern Lights Distributors, LLC has launched a long-only fund (the 13D Activist Fund) whose managers select stocks from the universe of activist positions. While the fund has a limited performance history, it has outperformed the S&P 500 year to date with a return of 26% compared to the index’s total return of 18%.

The 13D Activist Fund also notes that third-party academic research shows superior performance for activist targets and this is not entirely captured by a pop in the stock price immediately following the announcement. For example, “a further significant increase in share price” occurs after the filing date according to one study on the returns from activism.

To capitalize on this finding, the 13D Activist Fund specifically seeks to take positions in activist targets from a variety of managers, targeting “20 to 40” holdings. For purposes of comparison, Icahn’s most recent 13F only included a total of 19 positions, and some of these were in smaller-cap stocks (the 13D Activist Fund targets stocks with market capitalizations of at least $1 billion) or in companies where he was not making activist moves.

As a result, by construction its portfolio should incorporate ideas from several activists rather than mimicking any particular fund’s portfolio. The fund managers acknowledge that there is little fundamental analysis involved in their strategy; they prefer to defer on that point and analyze the activist investor’s record directly in determining the likelihood of positive returns.

To do this, they analyze both the overall track record of an activist as well as his success in a particular industry or sector; activists who have historically struggled in tech investments might be ignored if they file a 13D on a tech stock. They also evaluate the activist’s plans for creating change at the company. Different activist techniques might be judged more or less likely to succeed.

Recent data

Its most recent publicly disclosed data shows that the 13D Activist Fund’s three largest holdings were Jack in the Box Inc. (NASDAQ:JACK), where Blue Harbour Group has been engaged in an activist strategy for about three years; Valeant Pharmaceuticals Intl Inc (NYSE:VRX), one of the top holdings of Jeffrey Ubben’s ValueAct Capital, and Canadian Pacific Railway Limited (USA) (NYSE:CP), which has more than doubled in the last two years as Ackman has succeeded in transforming the railroad.

Motorola Solutions Inc (NYSE:MSI), another ValueAct holding, and Ackman favorite BEAM Inc (NYSE:BEAM) rounded out the fund’s top five picks. Looking at the rest of its top holdings, it appears that other activists the fund tracks include billionaire Paul Singer’s Elliott Management, Keith Meister’s Corvex Capital, and Richard McGuire’s Marcato Capital Management.

Final thoughts

Given the combination of the fund’s performance and the academic research supporting the concept of imitating activists, the basic concept involved seems to be a good one particularly for investors who are looking for assets with a low correlation to the overall market.

The question is which of the following would be the best way for an interested investor to participate: buy into the fund and pay its fees (likely the only way for most investors to access the entire portfolio of activist opportunities), watch for its public reports and directly buy some of the stocks the managers choose (which has a considerable delay), or follow 13Ds oneself and directly research these for attractive single-stock investments.

Disclosure: I own no shares of any stocks mentioned in this article.

Hedge Funds’ Small-Cap Picks Crush The Market

Article written by guest author Insider Monkey. Perhaps you've heard by now: Hedge funds have underperformed the S&P 500 year to date as the index is up 13% so far in 2013. 

Of course, hedge funds are often specifically designed to reduce an investor's exposure to the fluctuations of the overall market through long/short or other low-beta strategies, so this is not exactly the most level playing field on which to judge the utility of hedge funds.

In addition, when hedge funds can turn the full power of their research teams on under-served areas of the market, such as small cap stocks, we've shown that, far from being chronic underperformers, they can actually be excellent sources of alpha.

How can we determine this? Several weeks after the end of each quarter, each hedge fund files a 13F with the SEC to disclose many of its long-equity positions as of the end of the quarter. We track these filings in our database for a number of purposes, including to help us research investment strategies.

Last summer we found that, on average, the most popular small-cap stocks among hedge funds (measured by the quantity of funds in our database reporting a position) tended to outperform the S&P 500 by 18 percentage points per year.

At this point, we went to work stock picking — identifying which were the most popular small-cap picks based on 13Fs filed in November 2012. A number of these picks were merger targets; merger arbitrage is one of those low-beta strategies we've mentioned, as whether or not a deal closes is very weakly related to market conditions.

Let's take a look at the results since the beginning of this year for the five most popular picks which remain publicly traded: United Rentals (URI) is up 16%; Visteon (VC) has returned 34%; Tripadvisor (TRIP) is up 58%; W.R. Grace (GRA) is trading 13% higher; and Marvell Technology (MRVL) has soared 78%. You don't need a calculator to compare the average return of these names to the S&P's 13% gain, but we'll do it anyway: 39.8%. It's fair to note that small-cap stocks tend to outperform the overall market in good times, but still, Vanguard's small-cap ETF (VB) is up only 19% year to date.

Now consider: this portfolio comes from information released in November of last year, based on information about hedge-fund holdings from September. Buying these stocks at the beginning of 2013 would have been a very easy strategy to implement for investors with sufficient capital to buy five stocks and, even with a very substantial delay, would have resulted in a market-beating portfolio. These results are above what we've found to be typical, but demonstrate that strategies based on hedge-fund activity can realistically work.

Then why is it that overall hedge funds aren't beating the market? A few reasons. First, as we've mentioned, hedge funds often hedge by going short other stocks or the overall market in pursuit of absolute returns; they may also pursue more market-neutral strategies, such as merger arbitrage or investing in global macro instruments.

Second, the largest hedge fund positions — particularly for successful funds that raise billions in capital from investors — tend to be in large-cap stocks almost by necessity. Large caps are more closely followed by large institutional investors and the financial media, and so it is harder to generate alpha in these stocks.

When we looked at billionaire David Einhorn's Greenlight Capital's 13Fs over time, we found that he gets a good deal of his outperformance from small caps (read our analysis here).

Third, of course, investors in hedge funds pay performance fees. There are other reasons less positive for hedge funds as well — for example, a number of funds have been long gold this year, with disastrous results thus far.

Paying heavy fees to invest in a hedge fund is probably not worth it for most investors who don't have to concern themselves with finding investment opportunities uncorrelated with the rest of their portfolio (as many institutional investors do).

However, on average, hedge funds' consensus small-cap picks tend to do quite well. We believe that there are other strategies waiting to be discovered as well, and of course, investors can take advantage of 13Fs and the more up-to-date news from 13D and 13G filings (which occur when a fund or other major investor owns at least 5% of a publicly traded company) to identify free initial investment ideas.

Disclosure: none

George Soros Biggest Dividend Stock Buys And His Latest Portfolio

Georges Soros latest dividend stock moves and his asset allocation originally published at long-term-investments.blogspot.com. George Soros is a legendary and speculative driven hedge fund manager. He manages around $9.22 billion in his asset vehicle Soros Fund Management LLC. The money is invested in over 200 companies.

George Soros is a very active Trader. He bought 59 new companies, around 30 percent of his total assets. Half of his latest big stock purchases pay a dividend. The most important changes were made within the technology and cyclical consumer goods sector. 

He changed assets in this category with impact to his portfolio of around 8.7 percent or net 7.4 percent. Also important areas where he put money in were communication services and defensive consumer stocks. The 20 biggest stock purchases had an impact to his portfolio of around 14 percent.

George Soros is an unpredictable investor. He jumps on everything he believes to make money with. The positive thing is that he is a much diversified guy. 

None of his stock assets is too big to be over weighted. The biggest position has a 3.8 percent portfolio share. His 20 top stock positions represent only 31.5% of his portfolio value, including ETFs, the ratio rises to 47.7 percent.

The Truth About Hedge Funds

It’s time to set the record straight. Many members of the media have reacted negatively to the development that hedge funds will be allowed to advertise to the general public. A number of outlets have been critical of the hedge fund industry for some time due to the fact that some money managers have been accused of unethical behavior like insider trading, as well as the fact that many billionaires (about 40 to be exact) are hedge fund managers, somehow asserting that this means they do not need—or deserve—any additional clients.

In a gift to these critics, the relaxation of advertising rules comes as the S&P 500 ETF [SPY] has risen almost 30% over the last two years, meaning that if a particular hedge fund has only returned 10% per year over this period, it has underperformed the market. This cut-and-dry comparison makes it easy to poo-poo on the industry at large, but it’s frankly not that simple.

Yes, hedge funds indices have, in fact, underperformed the S&P 500 index recently, but that’s assuming that these indices contain the entire “universe” of 8,000-plus hedge funds in existence today. In reality, there are plenty of upper-tier funds that do not report their returns to hedge fund data providers. In addition, most of the hedge funds do not invest in plain vanilla stocks and comparing their returns to the S&P 500 index is absolutely absurd.

Many members of the financial media claim that hedge funds can’t pick winning stocks. They acknowledge that there are some hedge fund managers who can beat the market, but no one can pick “good” hedge fund managers before they prove themselves. Based on these two assumptions they conclude that investors should stay away from hedge funds. We are going to present evidence to the contrary. We will also explain why hedge funds invest in Apple [AAPL] and Google [GOOG] in droves.

Do Hedge Funds Know How to Pick Good Stocks?

Absolutely, yes.

We have a database of all 13F holdings for 92% of hedge funds between 1999 and 2009. According to our calculations hedge funds’ stock picks with market values between $1 billion and $10 billion outperformed the S&P 500 index by 10.3 percentage points per year (to be exact 82 basis points per month) during this 10 year period. Hedge funds’ large cap stock picks outperformed the market by 18 basis points per month or about 2.2 percentage points per year.

That’s not the all story though.

From a consensus standpoint, there is a specific range of small and mid-cap stocks that gives piggyback investors the potential to outperform the market indices by a huge margin. The most popular 15 small-cap stocks among hedge funds outperformed the market by 18 percentage points during this time period.

Wait, we know what you are thinking. These results only show that hedge funds were good between 1999 and 2009. How about the past 12 months?

We knew this question would be coming a year ago. So, we launched a quarterly newsletter that picks the 15 most popular small-cap stocks among hedge funds in real time. We launched this newsletter at the end of August 2012 and have been sharing our performance since. So how did these 15 most popular small-cap stocks perform since August 2012?

Much better. Our picks returned 54.5% through July 30^th, vs. a 22.1% gain for the SPY (see the details here). This can’t be explained by coincidence. Hedge funds are amazing at picking winners. We have the historical data and we have been testing this in real time. Our data confirms this fact.

Can We Pick Successful Hedge Fund Managers?

The second myth spelled out by uninformed financial journalists is that even though there are good hedge funds, there is no way that we can spot them before the fact. For every David Einhorn out there, there are dozens of unsuccessful hedge fund managers and we couldn’t know which one is which 15 years ago.

You know what? This is why hedge fund advertising will be beneficial for investors. Investors will have access to more information about hedge funds, their stock picks, their performance, interviews that shed a light on their character, and they will do a much better job at picking good hedge fund managers.

Picking good hedge fund managers is actually much easier than you think. If, on the whole, hedge funds weren’t good at picking stocks (i.e. their performance was purely random), then it would be impossible to pick good managers. However, once you know that it is possible to be good at selecting stocks, you will know that it is also possible to be skilled at finding quality hedge fund managers.

So far, Insider Monkey has endorsed one hedge fund manager based on the performance of his past stock picks: Michael Castor of Sio Capital. We even called him “the next David Einhorn” at the end of March. We also shared his top stock picks in the same article. Do you think his picks underperformed the market? Do you think his picks barely beat the market? Or do you think his picks absolutely crushed the S&P 500 index?  

Castor’s first pick, Cardinal Health [s:CAH], returned 21.5% since we published that article. Castor’s second pick, NPS Pharmaceuticals [s:NPSP], gained 76.5%. The S&P 500 ETF’s 8.2% return during the same period was also worse than Castor’s third pick’s - Anacor Pharmaceuticals [s:ANAC] - 15% gain. Castor’s three picks averaged 37.7% in four months.

We then checked in on Castor again in our June newsletter, where he discussed Rockwell Medical [RMTI] and Mazor Robotics [MZOR]. Since publishing that newsletter on June 10th, Rockwell is up 21.7% and Mazor has risen 17.2%. The S&P 500 index gained only 2.8% during the same time period. We don’t think every single one of Castor’s picks can beat the market, but if you can beat the market 60% of the time, you will have higher returns than billionaire Warren Buffett.

Are Hedge Funds Perfect?

Here is the truth about hedge funds. Their picks beat the market on the average and their small-cap picks have absolutely crushed the market indices. However, their large cap stock picks only beat the market by a couple of percentage points a year.

Hedge funds’ biggest sin is asset hoarding. There aren’t enough small and mid-cap investment ideas for all hedge funds. They have so much capital under management that they have to invest in large cap stocks such as Apple and Google. The problem is that they usually charge 2% of assets and 20% of profits, and these fees are generally higher than the excess return they generate by picking good stocks.

Hedge funds are taking advantage of investors not because they aren’t good at stock picking, but because investors don’t ask for their money back when hedge funds get too big. There are three simple solutions to this problem.

First, investors shouldn’t pay anything for hedge funds’ beta exposure. Second, investors shouldn’t invest in hedge funds that focus on large-cap stocks (or pay ONLY a management fee of at most 2%). The best way of doing that is investing in small and talented hedge funds like Sio Capital. Third, investors can do what we do: they can invest in hedge funds’ best stock picks without paying them a single dime. Our picks have outperformed the market by more than 30 percentage points. I haven’t heard of a lot of hedge funds that have done that over the last year.

Conclusion

Hedge funds aren’t that complicated. They are amazing at picking small-cap stocks and they are good at picking large cap stocks. It is also possible to spot great hedge fund managers by analyzing their historical performance. The problem is hedge funds are asset hoarders and they charge exorbitant fees. These fees are justifiable if they were only investing in small-cap stocks. Unfortunately they aren’t and this isn’t their fault. It is up to the investors to force hedge funds to invest in smaller-cap stocks, or to yank their money from hedge funds and do it by themselves. It is as simple as that.

Disclosure: none

David Einhorn: Fooling Some of the People All of the Time

Could 2008's credit crisis have been minimized or even avoided? In 2002, David Einhorn-one of the country's top investors-was asked at a charity investment conference to share his best investment advice. Short sell Allied Capital. At the time, Allied was a leader in the private financing industry. Einhorn claimed Allied was using questionable accounting practices to prop itself up. Sound familiar? At the time of the original version of Fooling Some of the People All of the Time: A Long Short Story the outcome of his advice was unknown. Now, the story is complete and we know Einhorn was right. In 2008, Einhorn advised the same conference to short sell Lehman Brothers. And had the market been more open to his warnings, yes, the market meltdown might have been avoided, or at least minimized.

• Details the gripping battle between Allied Capital and Einhorn's Greenlight Capital
• Illuminates how questionable company practices are maintained and, at times, even protected by Wall Street
• Describes the failings of investment banks, analysts, journalists, and government regulators
• Describes how many parts of the Allied Capital story were replayed in the debate over Lehman Brothers

Fooling Some of the People All of the Time is an important call for effective government regulation, free speech, and fair play.

Read more here: Fooling Some of the People All of the Time, A Long Short (and Now Complete) Story, Updated with New Epilogue