Four Investment Ideas You Can Take From What The Hedge Funds Are Doing

Four Investment Ideas You Can Take From What The Hedge Funds Are Doing
Carl Hazeley

over 1 year ago4 mins

  • Hedge funds had a tough start to the year, but that’s turned around in the third quarter, thanks to growth stocks in the information technology and consumer discretionary sectors.

  • The top pick among hedge funds right now is Amazon, while Microsoft, Visa, and Apple are up there. Their top picks tend to outperform the broader market and have already helped them this quarter.

  • Hedge funds are still underweight growth stocks versus value stocks, and history suggests those growth stocks should begin to rally from here, as long as inflation stays in check.

Hedge funds had a tough start to the year, but that’s turned around in the third quarter, thanks to growth stocks in the information technology and consumer discretionary sectors.

The top pick among hedge funds right now is Amazon, while Microsoft, Visa, and Apple are up there. Their top picks tend to outperform the broader market and have already helped them this quarter.

Hedge funds are still underweight growth stocks versus value stocks, and history suggests those growth stocks should begin to rally from here, as long as inflation stays in check.

Mentioned in story

Hedge funds are in the business of making money no matter what the markets do. And in times like this, it’s worth checking out what they’re up to. I recently did just that, and I discovered four big themes you can take advantage of now…

1. Hedge funds have had a promising start to this quarter.

Investment bank Goldman Sachs recently analyzed about 800 US-based, stock-focused hedge funds with roughly $2.4 trillion worth of investments. It found that, on average, their investments were down 12% in the first half of the year – but that a 4% gain so far in the third quarter has left them down “only” 9%, which is better than the S&P 500’s 14% drop so far this year.

What’s the opportunity here?

One way you can look to mirror hedge funds is by following their most popular bets on aggregate. That strategy would’ve lost you 22% this year overall, but if you timed your bets to the S&P 500’s June low, you would’ve been up around 18% by now, slightly outperforming the US market over the same period. That isn’t to say timing the market is easy, or indeed that it’s better than time in the market, but what it does suggest is that now might be a good time to consider buying back in.

2. Amazon is now the most popular hedge fund bet.

Of the 50 stocks that appear most often in the top 10 hedge fund holdings, Amazon is now the most popular, replacing Microsoft. Visa has replaced Apple in the top five. And overall, the group of hedge fund favorites has added 14 new members recently: AMD, Bank of America, Citi, Charles Schwab, Biohaven, Crown, Centene, Danaher, Elastic, MercadoLibre, Netflix, PayPal, RH, and Atlassian.

What’s the opportunity here?

The basket of hedge fund top picks has outperformed the S&P 500 in 59% of quarters since 2001, with an average quarterly excess return of 0.39%, making it a smart place to consider when looking for fresh ideas. It’s worth noting that the typical hedge fund has 70% of its buy ideas in its top 10 companies as of the end of last quarter. Hedge fund “concentration” hasn’t been this high since before the pandemic, and with the amount they changed their investments dropping to a new record low last quarter, it suggests these investors are battening down the hatches and making relatively focused bets. And that might mean now’s a good time to look more closely at their favorite stocks.

3. Hedge funds bought back into growth stocks.

Back in the first quarter, hedge funds ditched growth stocks, like those in the information technology and consumer discretionary sectors, while piling into value stocks, like those in the energy and materials sectors. That trend’s started to reverse: hedge funds added to their tech and consumer discretionary holdings, and cut some of their energy and materials ones. It’s a bet that’s worked well this quarter: tech has outperformed the S&P 500 by about 5 percentage points, and consumer discretionary by about 10.

What’s the opportunity here?

Despite the recent change in momentum, hedge funds are still “underweight” growth sectors like tech and relative to value sectors like materials and energy. In other words, compared to the amount you’d expect a hedge fund to have in each sector if they were aiming to match the overall composition of the market (i.e. about 25% tech, 12% financials, and so on), they’re still holding less tech and more materials and energy, even after adjusting their portfolios somewhat. So while hedge funds’ renewed interest in tech is probably encouraging, a smart way to interpret their interest is as rising optimism rather than as a sign to pile back into growth stocks.

4. Hedge funds are taking less risk overall.

Hedge funds’ “net leverage” – the difference between the amount they’re spending on long bets on companies and short bets – is still close to the lowest levels since March 2020. In fact, according to data calculated by Goldman Sachs, leverage is at the 27th percentile versus the past five years and the 11th percentile versus the last three.

What’s the opportunity here?

Hedge fund leverage settling down (and the outperformance of their most popular bets) is actually what you’d expect to see based on previous stock market selloffs. In most of the S&P 500 drops of 10% or more since 2011, hedge fund leverage and performance bounced back near the market’s bottom, just like they seem to have done since the S&P 500 low in mid-June. From here, history suggests hedge funds will start to take on more risk and their biggest bets will continue outperforming the market, albeit modestly, through the rest of this year. And that suggests now’s a good time to start working some of the hedge funds’ investing ideas above into your portfolio.

All that assumes, however, that stock markets remain broadly stable (or even rise) from here. And of course, that’s not guaranteed: one of the biggest risks to stock markets right now is inflation. If inflation comes in higher than expected over the next few months and the Federal Reserve hikes interest rates more than investors currently predict, then stock prices could take a serious tumble.

Finimize

BECOME A SMARTER INVESTOR

All the daily investing news and insights you need in one subscription.

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

/3 Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.

Finimize
© Finimize Ltd. 2023. 10328011. 280 Bishopsgate, London, EC2M 4AG