13F is a widely popular tool that provides retail investors a bit of access into the sophisticated world of hedge fund investments. In brief, they are quarterly filings that show each hedge fund manager's US-denominated stock and convertible debt positions in which hedge funds express portfolio ownership. They do not disclose shorts, although they must disclose ownership of puts, which express bearish sentiment. In many ways, 13Fs must be used wisely and discretely for the above reasons - it does not show the whole picture of the manager's strategy. For example, a long position in XOM by Berkshire Hathaway may not express a bullish view on XOM, but rather an undisclosed bearish view on CVX with a comparable hedge to offset sector risk.
Nonetheless, 13F, if used properly, can shed tremendous insight into the best trades by the brightest minds on a relatively timely manner for those who are willing to spend the time to learn about the hedge fund investing style's underlying characteristics as well as parsing and aggregating the data into a meaningful sample to avoid idiosyncratic outputs. This is exactly what I did, and I would like to share the results with you in two parts: 1) the entirety of the 3500+ fund's filings with specific qualifications, and 2) the most popular stocks based on solely long-term fundamentally driven hedge funds with proven track records.
Traditional Strategy: Stock picks based on Q3 2013 13F from All Fund holdings
Based on all fund holdings which are over ~2mm line items amongst 3500+ funds, the most commonly owned stocks are Johnson & Johnson (JNJ), Microsoft (MSFT), Apple (AAPL), Exxon (XOM), and General Electric (GE) in that order. These 5 were also the most commonly held stocks in June 2013, except MSFT was the popular then (which was up 20% in Q2).
Strategy 1: Stock picks based on Q3 2013 13F from Top Fund holdings
However, there is some bias introduced here due to the fact that holding a stock does not necessarily translate into conviction. To take this into account, we now use the concept of Top 5 or Top 10 Holdings. This adjusts for counting only those positions which are sorted from their top 5 or 10 largest positions in their portfolio. Upon such analysis, we find that AAPL, XOM, SPDR S&P 500 ETF Trust (SPY), JNJ, MSFT are the top positions respectively in that order (518 filers having Apple as one of their top 5 holdings!).
Strategy 2: Stock picks based on Q3 2013 13F from Concentrated Fund holdings
Still, this is incomplete - for it does not adjust for the fact that some positions may simply still remain unmeaningful in sizing. For example, some filers like Balyasny own 500+ stocks (biggest position is 2.83%), which do not translate into the same level of signaling as a fund like Greenlight which owns only 30 stocks (biggest position is ~20%). To adjust for this we now look at fund holdings based on positions meaning >5%. The results show that the most popular stocks are SPY, AAPL, XOM, JNJ, and new name, Google (GOOG).
Strategy 3: Stock picks based on Top Long-term Fundamentally-driven Hedge Funds' ownership
In my many years of experiences in the capital markets, both from the sell-side and buy-side, I have come to rank some funds to be better investors than others in a style of investing that is more appropriate for 13F filings. Greenlight is one of them. On their long portfolio's 30 positions, only 3 names are new, and more than half (!) remained unchanged even in sizing (meaning the fund neither added nor decreased exposure during the 3 month window - a sign of a true long-term investor). The top 10 funds I chose for this exercise are, 1) Lone Pine, 2) Blue Ridge, 3) Tiger Global, 4) Greenlight, 5) Kensico, 6) Pennant, 7) Appaloosa, 8) Baupost, 9) Viking, and 10) Slate Path. The results, which is very interesting, is as follows:
American International Group (AIG) is the most commonly held name, in which 6 of the 10 funds are long. Twenty-First Century Fox (FOXA), Workday (WDAY), Priceline (PCLN), and Visa (V) are the next four. All of these names are slightly more differentiated than the results from Part 1, which by divergence, is either alpha generating or not. So now let's look at the stories behind these names and what the hedge funds are betting on. I will discuss AIG and WDAY today.
AIG - the insurance industry has not fully recovered from 2008, but AIG is one in which substantial progress has been made. It is still trading at a 25-30% discount to book with a PE of 11x. As they are continuing to make substantial effort in paying off their preferred interest due, AIG's risk-reward is compelling given projected ROE improvement. Regarding 3Q 2013 results, AIG reported Op EPS of $0.96, above the consensus - however, pre-tax results were missed (18% tax rate versus the industry estimate at 30%), increased bottom line meaningfully at 13c/share. The biggest surprise in 3Q however was not the results - it was AIG management's suspension of its 10%+ aspiration ROE goals for 2015.
While this may appear to be surprising, I believe that it is not a vote for lack of confidence but rather a sensitive debate between private-public profit sharing. AIG's core insurance delivered $1bn in operating income, with core underwriting margins improving over 200bps year to year. This is where sell-side research vs buy-side insight must diverge - the sell-side has an obligation to internalize management guidance in their functions but the buy-side is free to interpret the statement as they would like. For example, Morgan Stanley above cannot choose to ignore explicit guidance provided by management in their capacity to fulfill fiduciary duties. AIG is a perfect example of why the hedge fund community intelligence might be a meaningful signal to retail investors like us in this way.
WDAY - WDAY's Q3 results were most impressive since the IPO. Billings growth of 99% was very strong and also meaningful as margin leverage were impressive despite stronger hiring. Overall, net new customers continued to grow meaningfully as 55-60% year on year customer growth was accomplished over the past 8 quarters (~20% ASP growth). Potential catalysts are Q4 earnings call, and major new customer wins with innovative financial offerings. The risks are obvious - competition from legacy vendors, and the lack of migration to SaaS. I believe this risk is minimal as the trend is already proven - the 40bn ERM market will be disrupted by the SaaS platform entering a multi-year refresh cycle of technology that is older than 10+ years. What is interesting to me about this name is that it has cheapened a little since the release of the Q3 2013 13F data, which means you can now access the same investment at a lower cost-basis. The 10 funds above are long-term investors most likely to hold the stock for 1-2 years, and so you can stay assured that a good entry is just that - a better cost basis by luck of technicals.
I hope that the above analysis has motivated the importance and relevance of how to use 13Fs. You can choose your own basket of funds to monitor by accessing my website for free and repeat the above exercises with your own discretion. Millions of research expenses are utilized in the hedge fund industry to extract alpha, and it is my belief that it can be extracted by retail investors like us complementing the fundamental research and view that each individual performs on his/her own. At the very least, it is a great way to discover new stock ideas that are relevant yet was personally unknown. I intend to continue developing the tools on the website for further granularity, and will publish a follow-up with enhanced features that should be of immense interest and novelty for your readership.