A Hedge Fund Clone Portfolio For 2007

Quick, what's the most popular hedge fund holding?

Hint: They have a BIG software release coming up.

Sifting through the holdings of 15 value hedge funds - and limiting each fund to 20 holdings - results in roughly 300 positions. The number of stocks that were repeated X-times is below

1X = ~300
2X = 31
3X = 10
4X = 4
5X = 0
6X = 1, Microsoft (MSFT)

With the help of a co-worker, I am currently delving through stacks of old SEC filings to backtest the Consensus portfolio. (Something to do when the Denver airport closes for two days.) We are taking a look at about 10 value funds since 2000, examining their holdings, and creating portfolios to see how our approach would have performed.

We first cull the list of stocks for each fund down to 20 names. We do this for a couple reasons. First, it eliminates any small positions, and it also equalizes the funds. (i.e. a fund with 100 names would be overrepresented vs. a fund with only 20 names). Second, hedge funds often have long positions in stocks they are actually short. This is called shorting against the box. The name comes from the idea of selling short the same stock that you are holding in your (safety deposit or strong) box. The term is somewhat meaningless today, with so many people holding stock in street name with their brokers, but the term persists. These positions are typically small, and taking the top 20 names, and consequently the consensus names, should eliminate most short positions.

Obviously our backtest will suffer from survivorship bias (we're not looking at any funds that have since gone out of business), but should give a pretty good indication of how the strategy would perform.

For the clone portfolio we will track in 2007, the year starts off with the following 15 names (repeated 3 or more times):

Apple Computer, Inc. (AAPL) - Technology, Personal CPUs
Ameriprise Financial, Inc. (AMP) - Financial, Asset Management
American Tower Corp. (AMT) - Technology, Communications
America Movil Mexican company (AMX) - Technology, Wireless
American Express Co. (AXP) - Financial, Credit Services
Autozone, Inc. (AZO) - Services, Auto Parts
Bed Bath & Beyond, Inc. (BBBY) - Services, Home Furnishing
Comcast Corp. (CMCSK) - Telecommunications, Broadcasting & Entertainment
Coach, Inc. (COH) - Consumer Goods, Textile/Apparel
Google, Inc. (GOOG) - Technology, Internet Information Provider
Microsoft Corp. (MSFT) - Technology, Application Software
Qualcomm Inc. (QCOM) - Technology, Communication Equipment
Tyco International (TYC) - Technology, Diversified Electronics
Unitedhealth Group, Inc. (UNH) - Healthcare, Plans
Western Union Co. (WU) - Services, Personal Services

The holdings are heavily represented in technology, with under-representation in healthcare, energy and materials. These holdings have many more of the typical growth features [high ROE, ROA, EPS Growth] than value features [P/E, P/B]. The average market cap is around $40B, which is to be expected because of the size of the hedge funds. I will tack on the closing prices as of 12/31/2006. You can also track this portfolio here.

And the names repeated 4 or more times:

America Movil SA de CV (AMX)
American Express Company (AXP)
Comcast Corp. (CMCSK)
Microsoft Corp. (MSFT)
The Western Union Co. (WU)

And the names of all the repeats:

Apple Computer Inc. (AAPL)
Ameriprise Financial Inc. (AMP)
American Tower Corp. (AMT)
America Movil SA de CV (AMX)
Arbitron Inc. (ARB)
American Standard Companies Inc. (ASD)
American Express Company (AXP)
AutoZone Inc. (AZO)
Bed Bath & Beyond Inc. (BBBY)
Baidu.com Inc. (BIDU)
Comcast Corp. (CMCSK)
Coach Inc. (COH)
ConocoPhillips (COP)
Cisco Systems Inc. (CSCO)
Covanta Holding Corp. (CVA)
Dell Inc. (DELL)
Eaton Corp. (ETN)
Federated Department Stores Inc. (FD)
First Data Corp. (FDC)
Fidelity National Information Services Inc. (FIS)
Flamel Technologies SA (FLML)
Google Inc. (GOOG)
Hospira Inc. (HSP)
International Game Technology (IGT)
Cheniere Energy Inc. (LNG)
Lowe's Companies Inc. (LOW)
LIVE NATION INC. (LYV)
Marriott International Inc. (MAR)
MDC Holdings Inc. (MDC)
Martin Marietta Materials Inc. (MLM)
Monsanto Co. (MON)
NIKE Inc. (NKE)
Nalco Holding Company (NLC)
Omnicare Inc. (OCR)
Qualcomm Inc. (QCOM)
Charles Schwab Corp. (SCHW)
Sears Holdings Corp. (SHLD)
Thermo-Electron Corp. (TMO)
Tyco International Ltd. (TYC)
UnitedHealth Group Inc. (UNH)
WellPoint Inc. (WLP)
Walter Industries Inc. (WLT)
Williams Companies Inc. (WMB)
Wal-Mart Stores Inc. (WMT)
The Western Union Co. (WU)

Comments

[User 1:]

Very interesting!

What 10 hedge funds did you use, and why those funds?

2006 Dec 21 10:28 AM

[WorldBeta:]

I picked the top 15 funds I considered to be the "best". You can find the full list here:

hedgefundclone.blogspo...

I included:

Baupost
Berkshire (obviously not a hedge fund)
Blue Ridge
Eminence
Greenlight
Maverick
Tiger
Private
Okumus
Gotham
Glenview
Glenhill
Alson
Pabrai
Perry
Lone Pine

2006 Dec 21 01:25 PM

[j'adoube:]

MebFa-

Like da metodology, mon. Let's look at da performance, two double zero sevon to date, mon:

As of 5/10/07

AAPL +26.5%
AMP +10.1%
AMT + 3.9%
AMX +19.6%
AXP + 4.0%
AZO +15.7%
BBBY +6.8%
CMCSK -7.7%
COH +12.0%
GOOG +0.2% Memo to MebFa --
MSFT +2.8% Don't put these two so close together.
QCOM +16.5%
TYC +6.2%
UNH -1.3%
WU -5.6%

I get an average weighted total return of +7.3% as of 5/10/07.
The S&P total return (basis VFINX) is +5.8% over the same period.

Now that certainly doesn't stink, MebFa. But I'm not yet ready to see you put on Judy Collins' old dress and start singing "Send in the Clones". Not even sure the extra return justifies the concentration risk --- [big pause] yet.

It's early. It's just inning three. And heck, one year is not even close to an adequate test period. Several of these guys have 3-5 year average holding periods.

Which leads me to a possible refinement. It would seem that results may improve if you filter out holdings that have "aged". That is, you want to accumulate stocks that are early in their hold cycle among the subject managers. If the average holding period among these managers is, say, three years, you don't want to buy stocks that are already held, say, for an average of two years by these managers, because they're already looking for the exits, perhaps. (On the other hand, the greatest gains on their holdings may come toward the end of their holds. Peter Lynch liked to say that his big gains often came in the thord or fourth year he held a stock).

Anyway, good work so far, big guy. Keep mining this rich vein. I'm there with ya.

j'adoube

2007 May 11 06:52 PM