Wed. Jan 29th, 2020

Hedge funds are making most of their money by piling into no-brainer wins like Apple and Amazon — and trades will only get more crowded


Hedge funds are making most of their money by piling into no-brainer wins like Apple and Amazon — and trades will only get more crowded

  • There are fewer public companies to invest in, and hedge funds have been desperate to match the surging markets, forcing many managers into the same trades and stocks. 
  • In the 2010s, the stock that generated the most alpha for hedge funds was Apple, according to Novus, a portfolio analytics company. Other well-known tech names like Amazon, Facebook, Netflix, and Microsoft were among the top 10. 
  • Investors increasingly list crowding as a concern, fearful of paying top-quartile fees for returns that matches the rest of the industry’s. 
  • Click here for more BI Prime stories.

The hedge fund trades of lore — like George Soros’ big bet against the pound or John Paulson’s wager against US housing  — were moves that no one saw coming, and examples of the cunning instinct of an expert of the markets. 

These days, though, the stock market moves making the most money for hedge funds are ones that don’t require years of experience deciphering balance sheets or a Wharton degree.

Apple has been the stock that has generated the most alpha for hedge funds in five of the last 10 years, including 2019, according to Novus, a portfolio analytics company.

Amazon was the stock that produced the most alpha for managers in 2015, and was also the third-best stock pick for the decade by hedge funds. The top pick was Apple, and Facebook, Netflix, and Microsoft were among the top ten.

It’s not just that these companies grew rapidly over the last ten years, benefiting all shareholders. Hedge funds lost their touch in finding little-known companies set to explode, according to Novus data.

On average, funds lost money on trades in companies with market caps below $2 billion over the last decade.

“We can see that stock-picking success has a relatively proportionate relationship to market cap,” a Novus blog post reads

Hedge funds, which ended the decade with another year of outflows and big-name closures, have struggled to beat the surging market for years now, and while the industry’s high fees steadily tick down, they’re still expensive compared to cheap index funds.

Just to keep pace, hedge funds have piled into some of the biggest names in technology, canceling out their advantages over one another. 

JPMorgan’s survey of more than 200 institutional investors from last year found that half of respondents listed crowding as their primary concern, with 82% blaming “limited opportunities” for the industry’s recent underperformance. 

The limited opportunity set is struggling to expand. The private markets are flush with cash — including from some of the same hedge funds that are struggling to break free in the public markets — and unicorns with no plan for turning a profit anytime are not interested in putting up with the scrutiny that has cut the valuations of Uber and Lyft, and nearly bankrupt WeWork. 

Hedge funds that have been riding the momentum trades in tech and telecommunications for years are exposed to a market reversion or a quick unwinding of trades by quants slams the sector.

September 2019 had big-name managers like Coatue, Lone Pine, and Winton Group losing big in a matter of days because of a drop in momentum stocks. 

Still, as one discretionary manager told Business Insider, “you see performance-chasing in places that have been successful” because people both like the companies and need to keep investors happy. Warren Buffett has even increased his stake in Apple in the third quarter of 2019. 

“I just wonder whether everyone stays the course or people get scared out of some of these more consensus positions,” the manager told Business Insider. 

Still, the days of uncovering a small gem of a company trading for less than what it is worth — a value investing technique that money managers have ridden to riches for decades — may not last for much longer.

Stephen Mandel Jr.’s Lone Pine Capital told investors that “structural changes in the economy” brought on by technology might make some companies appear like a good investment, even when their time has passed. 

“The backward-looking nature of factor investing thus overstates the value of ‘value.’ Past is not prologue,” the letter reads. The firm said it took advantage of the momentum slide in September to buy more of a favorite name: Netflix. 

Join the conversation about this story »

NOW WATCH: WeWork went from a $47 billion valuation to a failed IPO. Here’s how the company makes money.