Picking a Portfolio with Annualized Returns over 10% Since 2000

How many times have you heard that “crowded hedge fund trades don’t perform very well”? Over the past couple of years, research out of Goldman Sachs and others has shown that if you invest in companies that are owned by the largest number of hedge funds each quarter (i.e. most popular holdings), you will tend to underperform the broader market. Goldman’s basket of “20 most popular” stocks, for example, tracked the 20 most popular holdings amongst 700+ hedge funds. It found that over a 22-quarter period (Q3 ‘01 to Q4 ‘06), the basket underperformed the S&P 500 by an average of 17 basis points per quarter.

While we have no argument with Goldman’s findings, we would suggest that the question isn’t so much whether a stock is popular or not, but, in what group is the stock popular? To illustrate our point, the table below summarizes the annualized returns since 2000 of seven Top 10 Popularity clones available on AlphaClone. As a reminder, the Top 10 Popularity clone invests in the group’s ten most popular holdings each quarter.

Seven Top 10 Popularity Clones: Annualized Return (1/1/2000 to 4/3/2009)

Fund Group	Clone Return	Benchmark Return	+/-
Tiger Cubs	11.7%	-4.1%	15.8%
Concentrated Funds	10.3%	-4.1%	14.4%
Sector Picks: Basic Materials	11.4%	-1.0%	12.4%
Sector Picks: Consumer Non-Cyclical	13.3%	1.1%	12.2%
Sector Picks: Capital Goods	6.0%	-5.6%	11.6%
Sector Picks: Energy	13.2%	6.3%	6.9%
Hedge Fund Index	-2.9%	-4.1%	1.2%

Note that how a clone performs is very much correlated to the criteria used to define the group from which its popularity is then derived.

The Hedge Fund Index group is the poorest performer in the table, beating the S&P 500 Total Return Index by 1.2 percentage points annualized over the analysis period. Interestingly, just as the Goldman basket was based on a broad universe of 700+ hedge funds, this group selects popular stocks from the broadest data set of any other group in the table because it includes all hedge funds in our database (about 140) and doesn’t employ screens for sector or company size.

But don’t discount the Hedge Fund Index group just yet. The four Sector Picks groups in the table are based on the same universe of funds only screened for a specific sector and their popularity clones perform extremely well versus their sector benchmark index (we use S&P 500 Sector Indexes).

Last but by no means least, being popular amongst our Concentrated Funds group (those with the largest market values spread out across the fewest positions) or our Tiger Cubs group (former Julian Robertson protégés) means you returned 15.8 and 14.4 percentage points respectively in annualized excess returns since 2000 - stellar by any measure.

If anything, the above analysis goes to prove that being popular in investing is all about whom your fan base is, which is why we think that being able to select and clone your own fund groups is one of AlphaClone’s most valuable features.

Comments

[Old Trader:]

"Last but by no means least, being popular amongst our Concentrated Funds group (those with the largest market values spread out across the fewest positions) or our Tiger Cubs group (former Julian Robertson protégés) means you returned 15.8 and 14.4 percentage points respectively in annualized excess returns since 2000 - stellar by any measure."

What would the drawdowns be on these? Unless some number of the limited number of positions are hedges, I'd think the ride to those "stellar returns" might be rather bumpy.

Apr 07 08:05 PM

[AlphaClone:]

old trader,

Great question. Both portfolios had lower max drawdowns than the S&P 500 Total Return Index. Since 2000, the Concentrated Funds Top 10 Popularity clone had a max drawdown of -44.1%, the Tiger Cubs Top 10 Popularity clone had a max drawdown of -47.4% and the S&P500 Total Return Index had a max drawdown of -50.9%. If you are concerned about volatility AlphaClone lets you view several hedged versions on any clone.

Apr 08 01:35 PM