A common practice among individual investors is to check 13F filings and analyze them to see what hedge funds are buying. In theory, this practice should provide valuable advice. The 13Fs are limited in scope, required only to report U.S. equity holdings as of the quarter's end, and they don't include international holdings, short sales, derivitives or other assets that firms may manage. However, they can give us a valuable snapshot into fund ownership of U.S.-listed common stocks.
In its Hedge Fund Trend Monitor covering the fourth quarter, Goldman Sachs (GS, Financial) said that its basket containing the most popular positions among hedge funds has outperformed the S&P 500 in 59% of quarters since 2001.
However, those who have been utilizing this strategy in their stock-picking might want to make some changes to that strategy, in my opinion. Goldman's data shows that the most popular hedge fund positions during the fourth quarter of 2021 actually underperformed the S&P 500 year-to-date. The basket also lagged the index by 17% in all of 2021, its worst 12-month performance in 20 years. On a year-to-date basis in 2022, the most popular hedge fund positions have declined 12%.
Investors would be doing better in 2022 if they had invested in the S&P 500 compared to Goldman's Hedge Fund Trend Monitor, as the S&P 500 declined only 9% during the first two months of the year. For even better chances of beating the market, investors might want to look at the broader trends hedge funds are following rather than the individual stocks they are buying.
The most popular hedge fund stocks
The fourth-quarter 13F data reveals some interesting market trends. Perhaps unsurprisingly, hedge funds continued to rotate from growth stocks into value names. Anyone who follows news about the markets has surely read plenty of articles touting this rotation as fact. The data shows that hedge funds are certainly acting out this rotation.
However, most funds aren't yet ready to give up on their favorite high-flying tech names, and that's costing them. The top five most popular stocks being held among hedge funds during the fourth quarter were the FAAMG names: Meta Platforms (FB, Financial), Amazon (AMZN, Financial), Apple (AAPL, Financial), Microsoft (MSFT, Financial) and Alphabet (GOOG, Financial) (GOOGL, Financial). Microsoft was the most popular hedge fund position, followed by Amazon, Alphabet, Meta Platforms and Apple in that order.
Historically, popular hedge fund stocks during one quarter have gone on to outperform in future quarters, but that isn't what's happening now. Microsoft and Amazon are each down 12% year-to-date, while Alphabet is off 8%, Meta Platforms has plunged an astonishing 40% and Apple has declined 10%.
Concentrated positions
Aside from looking at the most popular positions among hedge funds, some individual investors zero in on the stocks with the highest concentration among funds. This strategy can also be effective sometimes.
According to data from Goldman, buying the most concentrated stocks in the S&P 500 outperformed the index in 61% of quarters over the last 20 years. Additionally, buying the 20 stocks in the S&P 500 with the highest concentration among hedge funds resulted in an average quarterly excess return of 1.72%.
In the fourth quarter, this trend did hold because the stocks with the highest concentration among hedge funds outperformed the S&P by four percentage points. However, if you continued to hold those stocks, you might have noticed a significant problem after the new year.
Bath & Body Works (BBWI, Financial), the most concentrated stock of them all, is down by about 24% year-to-date. Of the top 10 most concentrated stocks among hedge funds, most are down year-to-date, and those that were up significantly early in the year are now up in the low-single digits.
Of course, many stocks are in the red this year, so it isn't surprising that the top hedge fund stocks are too. However, investors shouldn't just assume that hedge funds are always picking the best stocks.
Better places to look for opportunities
Perhaps a better way for individual investors to make use of the data on popular hedge fund movements is to analyze it more generally instead of picking individual stocks. For example, hedge funds generally boosted their exposure to energy by 2.5%, especially oil and gas exploration and production, in the fourth quarter.
However, only one energy stock entered the list of the top 50 most popular hedge fund stocks, which was Cheniere Energy (LNG, Financial). While much of the rest of the market is down year-to-date, Cheniere Energy is up by almost 30%, a trend observed across the rest of the energy sector as well. Energy is the best-performing sector in the S&P so far in 2022, with a more than 20% increase.
Additionally, hedge funds slashed their exposure to the information technology sector by almost 6% in the fourth quarter, the largest change in any sector. Despite that, they kept the FAAMG names as their most popular positions, which was a mistake, as shown earlier.
Avoiding high-valuation stocks
Another broader trend that individual investors would do well to look at is hedge fund movements in the stocks with the highest valuations. Overall, stocks with enterprise-value-to-sales multiples of at least 10 times made up 28% of the U.S. equity market cap during the third quarter, the largest share since 2000. Meanwhile, those stocks accounted for one third of U.S. equity positions held by hedge funds.
However, that percentage fell to 27% during the fourth quarter, demonstrating an ongoing de-rating of the highest-valuation stocks. The share of stocks with an enterprise-value-to-sales multiple of at least 10 times fell to 17% of the U.S. equity market, so it seems likely that the share of hedge fund positions is continuing to fall.
However, when we look at these high-multiple stocks individually, we see that hedge funds continue to favor some names. Once again, the refusal to give up on these high-flying stocks is costing these funds. For example, hedge funds increased their net exposure to Tesla (TSLA, Financial) the most during the fourth quarter, but it's down by almost 30% year-to-date.
The rest of the top 10 high-multiple stocks with increases in ownership among hedge funds are all either in the red year-to-date, usually deep in the red and some as far as 40%, or up by 2% or less. As a result, I think that individual investors would be better off following the broader trends in the market, such as the rotation from growth to value, and ignoring the individual stocks that hedge funds are favoring.
