Hedge fund letters and 13F reports can be a great place to find investment ideas. However, they should only ever be used as a starting point for further research. Trading straight off these reports is one of the biggest mistakes investors can make and could lead to significant losses.
One of the biggest mistakes
There are a couple of reasons why it is not sensible to trade straight off these reports. First of all, whether it be a hedge fund letter or a 13F, these updates are always published after the quarter ends. For example, 13Fs are published within 45 business days after the end of each calendar quarter. A lot can happen between the end of the calendar period and the time the report is published.
Sometimes, trades are short-lived and last only a couple of months. By the time they are declared, the hedge fund might very well have exited the position. This is another fundamental reason why investors should never use these reports and letters to trade off.
Sometimes a hedge fund will provide a brief description of why it has decided to enter into a position. In my experience, many funds provide detailed analysis on at least one holding per quarter. It may be more, and it may be less. The point is, if a fund is explaining why it bought a position just four times a year in a portfolio with 30 positions or more, most of these may never be covered. This means investors may never know if the stock was bought as a hedging position or just as a short-term trade.
An excellent example of this was Berkshire Hathaway's (BKR.A) (BRK.B, Financial) buy of Barrick Gold (GOLD, Financial) in the second quarter of 2020. Some investors and analysts interpreted this as a sign that the conglomerate and the Oracle of Omaha, Warren Buffett (Trades, Portfolio), had finally decided to buy gold as they were worried about inflation. As it turns out, this was only a short-term trade. The conglomerate started selling the holding in the very next quarter. The position no longer features in the portfolio. There was never any explanation as to why the firm owned Barrick.
To give another example, looking through Baupost's 13F reports, we can see Seth Klarman (Trades, Portfolio)'s hedge funds own over 10 different SPACs. I don't know why he owns them, since they do not yet have any type of business operations or revenue. Does he like the managers? Did he help fund the deals? Is this an arbitrage trade? We can't draw any conclusions if we don't have any available information.
Owning shares as part of another deal is another reason why investments might appear in letters or on 13Fs. Investors following Lee Ainslie (Trades, Portfolio)'s Maverick Capital might have noticed that a new position appeared on the hedge fund's first-quarter 13F, and that was Coupang (CPNG, Financial). The fund owned 111 million shares with a 47% portfolio weight.
This might look as if Ainslie and the team have made a highly concentrated trade on a single stock, but that's not the case. Maverick has owned Coupang in its private equity funds for years. In the first quarter, the South Korean e-commerce group went public, realizing a huge profit for Maverick. The fund didn't have to report the private position, but it does as a public equity. The fund may have been selling down this position to reduce its weight in the portfolio since the IPO, or turn a profit on the IPO price.
These are all examples of why it does not make sense to follow investor letters or 13Fs without completing additional due diligence first. Moving into a position with only limited information can be a quick way to lose a lot of money.
