The Value of Ira Sohn (Hedge Fund Stock Picks)

There are a lot of people debating the value of stock picking events like the recent charity Ira Sohn Conference.  Felix Salmon and David Gaffen debate the usefulness (Felix responds here)  and Joe Weisenthal chimes in here.

There is so much misinformation in the 13F space, and most comments are simply not based in a firm understanding of what works and what doesn’t, but rather guesses.   But that is what most financial commentary is, guesses (ie all of the commentary surrounding buy and hold and market timing, what drives stocks, often has the feel of debating religion or politics).  I like reading David, Joe, and Felix but if you want to know what works and what doesn’t in 13F tracking you should be listening to people that have spent many years getting their hands dirty with the data and truly understand what works (and what doesn’t) like Jay at MarketFolly or Maz at AlphaClone.

There is also reams of academic papers on the subject including this paper from my friend Wes Gray at Empirical Finance that demonstrates ability to follow managers and disclosures.

Some of the comments:

Gaffen:  “Some of them (following hedge funds) work and some of them don’t…the more complicated you get and the more derivitives you get involved in the less you can follow…the ones that are slightly more straightforward you can follow.”  David is spot on here.

Felix:  “Trying to chase hedge fund managers is a fools errand…my big problem in all of this is that you and I have no ability to pick stocks and if we have no ability to pick stocks then what on earth makes us think we have the ability to think we can pick hedge fund managers.”  Clearly I disagree.

I am a quant.  I used to pour through these filings by hand a number of years ago (take a look at the blog archives back in 2006 and 2007), but being a quant I could never get comfortable with following these managers until I tested them.  I had an inkling that it worked but I wasn’t sure.  Like Fama says, “if it is in the data”…

…so my intern and I went and backtested 10 funds (Buffett, Blue Ridge, Greenlight, etc) and what we found is that there is huge value in tracking the funds that have lower turnover and derive most of their value from their long stockpicking book.  Like Gaffan says, there are some things that work and some that don’t – SAC doesn’t make sense to follow (too active), Rentec doesn’t make sense to follow (derivatives), and if you want more information there is an entire chapter on 13F tracking in my book.  The benefits, the drawback, what works and what doesn’t.

But like Salmon mentions, 13F tracking rests on two questions:

Can anyone beat the market?

Can you pick a manager ahead of time that will beat the market in the future?

Most of the academic literature suggests no to both answers (on aggregate).  But does that mean someone cannot answer yes to both questions?  Of course not.

We can all backtest until the cows come home but all that matters is real time performance of course.  We profiled three funds in the book, and taking their top 10 holdings, and rebalanced quarterly, 2/3 outperformed the S&P since publication (using beginning of 2009).  On average the three outperformed the S&P by 3.5% a year.

That is solid alpha.

S&P500 since book publication:  54%

Blue Ridge since book publication:  92%

Greenlight since book publication:  44%

Berkshire since book publication:  63%

FOF approach since book publication (top 5 holdings from each):  66%

All data courtesy AlphaClone.

Later in the chapter I included a list of 54 funds that I thought would be interesting funds to follow.  Out of that 54, 8 were never added to the database.  Excluding the  never added, the other 46 funds beat the S&P 500 by an average amount of 15 percentage points per year. (Historical research shows that following Buffett since the 1970s would have resulted in >10% outperformance per year – and he has beaten by 8% per annum since ’00.  So much for all those detractors that say he isn’t a good stockpicker!)

Roughly 80% of the funds beat the S&P500 over the time period.  Impressive real time results!  To be fair a lot of that outperformace came in the 2009 rebound, but the funds outperformed by 7% on average in 2010 as well (2011 a wash so far).

(Not to mention 13F tracking would have kept you out of Galleon.)

So, at the end of the day would you rather listen to Seth Klarman or your local broker when picking stocks?

Funds included in analysis:

Abingdon Capital Management
Abrams Capital
Akre Capital Management
Alson Capital Partners
Appaloosa Management
Atlantic Investment Management
Barrington Partners
Baupost Group
Bridger Management
Cannell Capital LLC
Chesapeake Partners Management
Chieftain Capital Management (BW)
Cobalt Capital Management
Defiance Asset Management
Eagle Value Partners (Witmer)
Eminence Capital
Fine Capital Partners
Glenhill Advisors
Glenview Capital Management
Highfields Capital Management
Icahn Capital LP
Jana Partners
King Street Capital
Lane Five Capital
Libra Advisors
Lone Pine Capital
Maverick Capital
Newcastle Partners
Omega Advisors
Pabrai Mohnish
Pennant Capital Management
Perry Capital
Pershing Square Capital Management
Private Capital Management
Relational Investors
SAB Capital Management
Scion Capital
Second Curve Capital
SemperVic Partners
Shamrock Activist Value
Steel Partners
T2 Partners Management
Thames River
Third Point
Tiger Global Management
Tontine Associates
Trafelet Capital Management
ValueAct Holdings
Viking Global Investors
Wyser-Pratt Management
Yaupon Partners