Cloning whales

November 27, 2015 01:00 PM

There have been countless articles written on active vs. passive investing. They almost all conclude that over time only 15% to 20% of active funds outperform their passive benchmark. The underperformance is usually attributed to the higher fees. Some managers hug a benchmark for job security, which limits the manager’s ability to add value and produces a “closet index.”   

Hedge funds typically operate on the other end of the spectrum, going anywhere to find a great investment. Investing with hedge funds is not without headaches:  Many top funds have reached capacity, and  even if  they are open to investments, their minimum investment levels are prohibitvely high.

Investors who understand how to use the information publicly disclosed on Securities and Exchange Commission (SEC) Form 13F can drastically improve their chances of outperforming the passive benchmarks. This information gives individual investors indirect access to activist manager  expertise in selecting stocks and allows them to reduce their reliance on lower-return investments such as mutual funds.

The 13F disclosure is required under SEC rule 13(f) from any manager that exercises investment discretion over $100 million or more in marketable securities within 45 days after each quarter. They reflect investment managers’ ownership interests in companies traded on U.S. exchanges. The data can be enormously helpful in giving everyday investors insight into the decisions of the leading hedge-fund managers and, more importantly, institutional money flows as with  the futures Commitment of Traders report. 

In short, you can use this information to create your own investment portfolio from those of hedge-fund managers, thus removing the fees that hamper professional money manager returns.  

Which manager(s) should you follow? One key metric is WhaleWisdom’s proprietary WhaleScore. The WhaleScore is designed to help investors identify hedge funds that are relatively easy to replicate. Based on replicability and performance, it scores them on a scale of 0 to 100 (see “Replication scorecard”). Each fund that qualifies for the WhaleScore is ranked against the S&P 500 and the other funds over a variety of metrics. Replicating each of the hedge funds that have been assigned a WhaleScore — by creating equal-weighted portfolios of their top 20 holdings — has on average outperformed the S&P 500 over the ensuing three-year and five-year periods 50% of the time (see “Drafting on activists”).

By avoiding the institutional constraints inherent in mutual funds and accessing the investment ideas of the world’s best hedge funds through replication of one or more 13F strategies, average investors can greatly increase their chances of outperforming the passive benchmarks.

About the Author

Brent Plunkett is the co-owner of and CEO of Charter Wealth Management.  WhaleWisdom helps investors research and replicate the portfolios of top hedge funds through their publicly available SEC disclosures providing access and tools to invest like a Wall Street money manager at a Main Street price.