Traders work on the floor at the New York Stock Exchange.
Brendan McDermid | Reuters
Sometimes following the crowd can be a profitable strategy, particularly if that crowd is composed of hedge fund managers who have been beating the market.
While investing often seems like a contrarian game where going against the flow feels like the better bet, the reality is that investors who bought the most-favored stocks have seen the best returns, according to a Goldman Sachs analysis of some 855 hedge funds whose assets total $2.1 trillion of the industry’s $3.2 trillion total.
“Despite the strong track record of popular hedge fund stocks, investors often view high ownership as a negative trait when evaluating stock prospects. Clients often ask us to include hedge fund ownership data in stock screens, expressing a preference for buying ‘under-owned’ stocks,” Goldman strategist Ben Snider said in a report for clients. “In fact, during the past decade hedge fund popularity has been a more useful criterion for selecting stocks than valuations.”
Overall, the funds in the firm’s coverage universe have returned 8% year to date.
But the basket of stocks with the most popular long positions and the highest concentrations have performed far better, returning 18% to easily outdistance the S&P 500, which had gained 15% through the first quarter, the period during which Goldman conducted its review.
That hasn’t been the case just this year.
Since 2001, stocks appearing in the top 10 portfolio positions have beaten the S&P 61% of the time, with an average excess return of 0.55 percentage points. Funds that hold the most shares of those stocks have beaten the market 63% of the time, with an average excess return of 1.96 percentage points.
“The signals from hedge fund popularity and valuation have been particularly useful in combination, especially for investors with slightly longer investment horizons. During the past decade, popular stocks have generally outperformed unpopular stocks across both 3- and 12-month investment horizons,” Snider wrote.
The results come at a time when hedge funds overall have been criticized for their high fees and less-than-market returns.
Looking at the entire industry and its nearly 10,000 funds, the gain through April was 7.2%, as measured by the HFRI Fund Weighted Composite Index, compared to the S&P 500’s total return of 18.2% through the period.
That makes stock selection all the more important.