Want to Buy What the Hedge Fund Geniuses Own? Better Read This First

In the next few weeks, Goldman Sachs’ (GS) David J. Kostin will publish his quarterly “Hedge Fund Trend Monitor” naming the stocks that managers are most enamored with now. This invariably will tempt some individual investors to follow popular wisdom and buy the shares on the list, particularly the list that shows the 20 companies with the highest percentages (concentrations) of shares held by hedge funds. Perhaps revisiting last year’s experience will moderate that urge.

Investors who bought shares individually in all Top 20 stocks last year lived through some particularly gut-wrenching plunges, accompanied by some less-than-moderating rises. Ten stocks marked gains and nine dropped in value. (Novell, whose takeover by Attachmate was well-underway by late 2010, delisted early in the year.) The funds piled first into AutoNation (AN), up 31% in 2011, and second into Sears Holdings (SHLD), down 57%. To get an idea of just how mixed this bag of stocks was, take a look at last year’s performance by the Top 10. They’re in order of popularity ranking.

Autonation Stock Chart

Autonation Stock Chart by YCharts

Tenet Healthcare Corporation Stock Chart

Tenet Healthcare Corporation Stock Chart by YCharts

Individual investors hanging on to the list got particularly shafted in late summer, when the hedge funds decided to raise cash. CBRE Group (CBG), a growing commercial real estate management company whose shares had climbed some 40% in early 2011, became a popular piggy bank. Such selling decapitated several companies that had been fine performers.

CBRE Group Stock Chart

CBRE Group Stock Chart by YCharts

Ultimately, the 2011 experience just throws a bit of caution on a strategy that traditionally performs very well for investors. According to Goldman’s last report in November, a weighted basket of Top 20 shares has outperformed the market 69% of the time since 2001, by an average 271 basis points per quarter (not annualized). Goldman notes that the strategy tends to work well in an up market but poorly in a down one.

For individual investors, it makes perfect sense to tap into the wisdom of people who usually make a whole lot of money picking stocks. Just understand that even they sometimes buy Sears.

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

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