Following the Smart Money in Hedge Fund Land

Apple (AAPL) announced a great quarter and was up almost $9 yesterday to nearly $200, an all time high.  Visa (V) and MasterCard (MA) are also at 52-week highs (Julian Robertson just mentioned he still likes them at the recent VIC conference).  Why do we mention these three stocks?

These three stocks are the top three most popular stocks in the World Beta clone. If you are a long time blog reader you know what that this, if not, a little background…

If you are one of the best doctors in the country, chances are you are working somewhere like the Mayo Clinic.  Or perhaps you may be at Johns Hopkins, UCSF, or even the Cleveland Clinic.  But it is rather unlikely (as much as Michael J Fox would have you believe in Doc Hollywood) that you will be the family practicioner in Grady, SC.  (And that’s no knock on SC, I’ll be giving a speech in Kiawah here in a few weeks and couldn’t be more excited.  Drop me a line if you’re nearby!)

Simply, the top talent in each in industry gravitates to where the best compensation is.  That’s capitalism.

In basketball that is the NBA (not Europe).

In acting it is NYC , London, or LA (not South Dakota).

In investing, it is hedge funds (not mutual funds and certainly not broker dealers or wirehouses).

That is one of the reasons we started AlphaClone – we wanted insight into what the best minds in the business were buying.  I started tracking a portfolio of 10 hedge funds way back in 2007.  Long time readers of my blog will recall how I used to backtest these funds by hand – it took me a couple months with a co-worker to do only a few funds (which now takes seconds on AC).

I started tracking a group I called World Beta.  It simply invests in the 10 most popular stocks amongst these 10 managers:  the Baupost Group, Berkshire Hathaway, Blue Ridge Capital, Eminence Capital, Greenlight Capital, Lone Pine Capital, Maverick Capital, Okumus Capital (we did a real time switch to Appaloosa in 2009), Private Capital Management, and Tiger Capital Management.  When I backtested the returns we found outperformance of a stunning 15% a year.

Real time, out of sample results are annualized returns of 25% a year vs. -6.8% a year for the S&P500.  That equates to a difference of over 100% in total return in that time period.  While the S&P500 lost almost 20%, the World Beta clone almost doubled.

That is the best proof of any systematic system – real time results, and in this case they were not only confirming but better.  Every stock but 1 is hitting a 52-week high right now! (QCOM is the one exception.)

For fun, we entered the holdings into Monrningstar’s X-Ray.  The portfolio is more expensive (Price to Book and Price to Earnings), but it is also growing EPS faster.  Even more interesting, the average distance from 52-week highs is -1.7 % while the average stock in the Russell 2000 is currently -15% away from 52-week highs.  We found very similar results when we looked at the holdings way back in May 2007, namely, that these value funds were (are) finding the most value now in large cap growth.

(Disclosure: Long all the stocks mentioned in this post).

Equity Curve below: