World Beta Blog

Miami March 12 & 13 if anyone is around.
(This Thursday and Friday.)

And I thought mutual fund investors were bad at timing.  Nice new paper, and of course, a great summary from CXO:

"The aggregate annualized dollar-weighted return from hedge funds to investors is on average about 4% less than the comparable passive buy-and-hold hedge fund return (compared to 1.5% deficits between dollar-weighted returns for broad stock indexes and mutual funds relative to buy-and-hold)…In summary, actual hedge fund investor return/risk experience, due to the timing of entries and exits, is much worse than that indicated by the continuously measured returns and volatilities of the funds themselves."

"Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn" Dichev and Yu.

Abstract:     
This study makes a critical distinction between the returns of hedge funds and the returns of investors in these funds. Investor returns depend not only on the returns of the funds they hold but also on the timing and magnitude of their capital flows into and out of these funds. The capital flow effect exists for any investment but is especially relevant for hedge funds because of the large magnitude and variation in the associated capital flows. We use dollar-weighted returns (a form of IRR) to assess the properties of actual investor returns on hedge funds and compare them to buy-and-hold fund returns. Our first finding is that annualized dollar-weighted returns are on average about 4 percent lower than corresponding buy-and-hold fund returns. This performance gap rises to as much as 9 percent for "star" funds with the highest buy-and-hold returns and for funds with high volatility of capital flows, a remarkable difference in assessing long-run investment performance. In addition, dollar-weighted returns are below comparable returns for broad-based stock indexes. Our second finding is that dollar-weighted returns are more variable than their buy-and-hold counterparts. The combined impression from these results is that the return experience of hedge fund investors is much worse than previously thought.

From Investopedia:

"In 1939, with Hitler’s Germany ravaging Europe, John Templeton bought $100 of every stock trading below $1 on the New York and American stock exchanges. Templeton’s trade got him a junk pile of some 104 companies, 34 of which were bankrupt, for a total investment of roughly $10,400. Four years later he sold these stocks for more than $40,000!"

If you ran that screen today it returns about 300 stocks from a list of 2500.  

If you then sort the stocks by # of insider buys it returns the following symbols:

ADK

CFW

DRJ

END

ETM

FOH

GLA

GMO

GSB

GTF

GTN

HH

IHR

NTN

OMN

OPK

ROX

RPI

TCX

XFN

Some truly nauseating charts in there!  Strong caution – a lot of these funds are teeny microcaps with little volume. . .values ranging from $150 million to $5 million.

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Some of the big boys not adding a lot of value.  Data from SGAM.

.

What public funds out there specialize in closed-end fund discounts or arbitrage? My list is below that I will add to:

ADANX
FOF
GCE (No volume, ETN)
TFSMX

Leave a comment if you know any others.

"Concentrate your energies, your thoughts and your capital. The wise man puts all his eggs in one basket and watches the basket." – Andrew Carnegie

One of the coolest features in AlphaClone is the ability to view dynamic groups.  One such group we call "Concentrated Funds".  Concentrated Funds are managers who have a large overall portfolio value but spread across a small number of equity holdings. Translation – they have high conviction in their picks.

This group combines the 25 funds with highest total market values but who have less than 50 total equity positions in their most recent filing.  The list of managers can change quarterly, but there isn’t that much turnover Q/Q.  Notice that the strategy makes no distinction regarding the style of the manager, or to their value added (destroying) abilities. 

Taking the top 3 holdings from each fund, equal weighted and rebalanced quarterly, outperforms the market by 11% a year since ’00. 

Taking the 10 most popular stocks from these funds, equal weighted and rebalanced quarterly, outperforms the market by over 15% a year since ’00.  These 10 holdings are beating the market in 2009 by 20%.  Yes, 20%. 

You can view the current holdings here.  When you type them into the Morningstar X-Ray it spits out on aggregate that they have valuations in line with the S&P 500 but growth rates 2X the S&P.  On average the stocks are 43% from their 52-week highs vs. 58% for the average stock in the S&P 500.

Below are the current funds.  Out of curiosity I took a look at the funds back in Q4 2001, and only the funds in bold were on both lists:

Baupost Group

Berkshire Hathaway

Blum Capital Partners

Bridger Management

Ichan

Chieftan Capital Management

Eminence Capital

Eton Park Capital Management

Fairholme Capital Management

Glenview Capital Management

Highside Capital Management

ICAP

Lone Pine Capital

Longview Asset Management

Paulson & Co.

Pershing Square Capital Management

RBS Partners

Relational Investors

Sands Capital Management

Southeastern Asset Management

TPG-Axon Capital Management

Tremblant Capital

Tiger Global

ValueAct

Viking Global

AQR launches the diversified arb fund (ADANX).  The Fund invests in a combination of arbitrage strategies such as merger arbitrage, convertible arbitrage, and (one of my favorites) closed end fund arbitrage.  But seriously, talk about a low benchmark! 90-day Tbills…

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Embarrassed to work in finance?

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Great PDF here from Witney Tilson – "Words of Wisdom"

"One way of dealing with information being more available is to stop playing the game and seek out securities or asset classes where there’s less information or competition."
Seth Klarman, 9.30.08

"There’s a clarity that comes with great ideas: You can explain why something’s a great business, how and why it’s cheap, why it’s cheap for temporary reasons and how, on a normal basis, it should be trading at a much higher level. You’re never sitting there on the 40th page of your spreadsheet, as Buffett would say, agonizing over whether you should buy or not."
Joel Greenblatt, 10.31.06

"We use a lot of grapevine ideas, asking people what they’ve finished buying that might be interesting. Why not look at what other great investors have found?"
Bruce Berkowitz, 4.28.06

[Hey you know I agree there!]

Okay, maybe I should be more clear.  Blindly following hedge funds through 13F filings is a terrible idea.  There are countless sites that focus on hedge fund filings and they are not going to tell you they offer little value, because then they have no reason to exist.  Building a backtesting engine is not a trivial exercise (believe me it is incredibly non-trivial to do it correctly). Some of the i-banks offer products based on hedge fund tracking, but most base their data off FactSet/LionShares which has survivor bias rendering it dangerous.

To give you an example let’s take a look at the most viewed portfolios on StockPickr.  James is a friend of mine and I am not trying to pick on him here but his is the best of the free sites (including two that give me motion sickness).  The top five most viewed portfolios on StockPickr are:  Buffett, Soros, Ichan, Pickens, and Renaissance. 

But here is the problem – the investor has no idea if following these funds is worthwhile.  These five portfolios have been viewed over FIVE MILLION times. 

Here is the kicker:

If you take a simple portfolio of the top 10 holdings, four of the five portfolios have no excess returns over their benchmark.  On average these fund clones underperformed their benchmark by 10% (ie I used the S&P500 except in the case of Pickens where I used S&P Energy).  If you include transaction costs then it is even worse.  In other words, investors are wasting their time and their money.  In many cases it is costing them money by tracking funds that underperform the S&P 500.  On average these funds did about 10% worse than the S&P500 since 2000. 

Using AlphaClone I have been able to identify value added algorithms and alpha in the areas of:

1.  Persistence in Returns – Do top managers continue to outperform?  Are there factors that contribute to over/under performance?

2.  Manager Selection – Can you identify managers ahead of time that will outperform, and if so, how?

3.  Static Hedging – Is it possible to hedge the portfolios in a way to increase risk-adjusted returns, and if so, how?

4.  Dynamic Hedging – Is it possible to dynamically hedge the portfolios in a way to increase risk-adjusted returns, and if so, how?

5.  Security Selection – What holdings yield the best return for a manager?

6.  Custom Strategies -  Are there other strategies that can yield better returns?  What about the most popular stocks?  New buys from the manager?

All 6 of these valued added findings cannot be learned from sites that do not let you backtest properly to 2000 without survivor bias in filings and stocks (this is huge by the way).

No, I am not going to tell you what these findings are (they will be the basis for some upcoming funds), but if you are an AlphaClone user and find some gems drop me a line and I am happy to chat with you.  It is something I have not published nor intend to. 

And just so you don’t think I am grumpy I will throw all of these sites a bone – following the top holdings is not the best way to follow these funds. 

[And don't even get me started on the social investing sites -  I am biased here, but I would much rather Warren Buffett, Bruce Berkowitz, David Einhorn, and David Dreman manage my money than some teenager on his computer trading microcaps with 10,000 shares daily traded. Maybe a longer post on this topic later].

How about a little quiz?  The first correct answer in the comments will get a free copy of my book The Ivy Portfolio when it prints in a week…

What fund manager’s top 10 holdings clone beats the market by 10% a year since 2000 (and actually outperforms his fund)?  The current holdings are:

WLP

UNH

WCG

URI

TAL

FUR

WTM

WSC

…and the people in this video are buy and hold investors.  A little humor for a nasty day. (Hat Tip: MK)

I’m at the DEMO conference in Palm Springs – if any readers are there let me know…