The Wall Street Journal recently had an article titled "The 50 Stocks Most Loved by Hedge-Fund Managers." I have to say the title caught my attention since hedge funds are supposed to be run by some of the smartest investors around. My curiosity, or it may be my bias, getting the better of me, I wanted to look at their holdings and see how it compared to what I thought a typical dividend growth portfolio might consist of. What do they love compared to what I might love to hold? I'm a retired dividend growth investor so I also approached it from a standpoint of what do they hold that I might want to consider to increase the income in my own portfolio.
They're called hedge funds for a reason, which means they hedge their holdings using various methods. One of the more common methods is to take short positions on stocks, and the Journal also had an article of the 50 most heavily shorted stocks by hedge funds. I glanced at it but only saw a couple of stocks on it that I knew paid dividends.
From the most loved list, there were 35 out of the 50 companies that paid dividends. The average yield of the overall list was 1.39%, but that is from the perspective of the top 50 making up an entire portfolio. Removing the 15 that didn't pay dividends, the yield was 1.98%. From a retiree standpoint, 1.98% is an unacceptable yield to be depending on for income.
I decided to look at the top 10 stocks. Here's the top 10 list:
Number of Hedge Funds Owning Stock
Total Return YTD
American International Group
JP Morgan Chase & Co
Bank of America
The first thing I noticed on the top 10 was that there were no dividend champions on it. In fact out of the entire Champions, Contenders, and Challengers list (CCC list maintained by David Fish), there were only 12 stocks that made the cut. And in the top 10, there were only 2 contenders, MSFT and QCOM. Taking the top 10 dividend paying stocks, the average yield was 1.64%. That meant removing GOOG and GM since they don't pay dividends and adding Visa (NYSE:V) and Anadarko Petroleum (NYSE:APC) to make up the top 10 dividend paying stocks.
In fact I had to go all the way down to number 38 on the list to find a dividend champion, Johnson & Johnson (NYSE:JNJ). Besides JNJ, there were 3 other champions on the list: Procter & Gamble (NYSE:PG) at 42, Exxon Mobil (NYSE:XOM) at 44, and Coca-Cola (NYSE:KO) at 46. There were 4 companies on the list that were shown as deletions on the CCC list because of dividend cuts. They were Bank of America (NYSE:BAC), Pfizer (NYSE:PFE), Wells Fargo (NYSE:WFC), and General Electric (NYSE:GE). BAC, WFC, and GE cut their dividends during the recession. I'm not sure about PFE.
Comparing the bottom 10 dividend payers, the list looks like this:
Number of Hedge Funds Owning Stock
Total Return YTD
Johnson & Johnson
Zoetis, Inc. Class A
Lyondell Basell Industries
Merck & Co.
The Williams Companies
Coca Cola Company
*Article didn't provide and I obtained from the Internet
The average yield of the bottom 10 dividend paying stocks was 2.67%. While that's better than the top 10, it's still not a sufficient yield to meet the income requirements for a retiree.
One other thing that jumped out at me about this top 50 list was that Berkshire Hathaway (NYSE:BRK.B) didn't make the list. That struck me as odd, but then maybe the return hasn't been sufficient for their criteria.
From a personal standpoint, out of the top 50 list, I was only long 5 of the companies on the total list. Those were Microsoft (NASDAQ:MSFT), Johnson and Johnson, WFC, Procter & Gamble, and Coca-Cola Company. Using a 2.5% dividend yield as a minimum threshold, there were only 15 companies that would make that cut. And many dividend growth investors wouldn't accept yields that low, opting instead for 2.75% or 3% as a minimum. Only 6 companies on the list had yields of 3% or higher. To be honest, that surprised me. Where's the love for dividend growth investing?
It is obvious these hedge funds aren't buying these most loved stocks for their yield but rather for their return. The average return for the top 10 was 19.60% and the return for the bottom 10 was 13%, but both of those returns include non-dividend payers. Using just the dividend payers, the return was 18.9% for the top 10 and 13.25% for the bottom 10. That is using the returns from the article and it didn't specify whether the returns included dividends or not. The return for the entire top 50 was 21.98%.
Interestingly enough, the same article had another link to an article that indicated the typical hedge fund had only returned 4% this year. That indicates to me that while these top 50 may be the most loved stocks held by hedge funds, they're holding a lot more that are dragging down returns, and possibly their hedge positions are costing them significantly in the returns department.
There's an image that hedge funds make a lot of money, and that may be true in some instances. But that doesn't mean they're right for the individual investor, as this article indicates. And my admittedly limited study of hedge funds and their associated fees indicates that most of the money made is predominantly by the owners of the hedge funds, not the clientele. A typical 2% to 4% management fee plus a 20% performance fee can eat away profits pretty quickly and in a down year, the client still pays.
What did this little exercise tell me as a retired dividend growth investor? To me it confirmed that my focus on income rather than returns is exactly where I want to be. Simply using the returns shown for the 5 stocks from the list that I hold -- stocks that I selected not for return but for dividend growth income -- the return is 22.2%. In reality that doesn't mean anything since it's only five I hold from the list of 50 and my other holdings would change that return. But my point is that my focus is on the income and if one gets the dividend growth right with quality companies purchased at fair or under-valued opportunities, the returns naturally follow.
There are many ways to make money in the stock market. But my outlook is that I'm not in the market to make money, I'm in the market to make income. Some may think that's the same thing, that I'm playing with semantics, but I don't see it that way. Focusing on making money via returns means I move in and out and try to time the market, which increases the probability of losing money. Or I buy an index fund that may hold companies I don't want and not meet my income requirements. Focusing on making income means I hold quality companies and watch fundamentals to ensure the dividends keep growing, and then watch the income grow.
As a retiree, I don't want to worry -- in fact, I can't be worrying about making a good return this year and then worrying about a market pullback next year and having to sell stocks for income that have now dropped in price. So I buy companies and hold them for the income with no intention of selling off a percentage each month, quarter, or year.
The way I see it, by obtaining quality dividend paying companies with a history of growing dividends, with adequate yields that meet my income requirements, and owning enough of them to provide diversification that reduces my risk of any one company doing significant harm, I own and manage my own personal hedge fund. And I keep my management fees and performance fees in my own pocket. And I'm loving that!
Additional disclosure: I am not a professional investment advisor, just an individual handling his own account with his own money. You should do your own due diligence before investing your own funds.