Using the information from SEC-required 13F disclosures has proven to be an effective way to access world-class investors’ stock-picking prowess without the expense of investing directly in hedge funds. Combining 13F manager strategies with a “fund of funds” approach removes the risks of investing with a single manager.
Creating a fund-of-funds portfolio begins with identifying the managers that will make up a fund group. Let’s assume you choose 10 managers. Security selection is the next step. You could choose to own the top five or 10 stocks that each manager owns, thus creating a diversified portfolio of 50 to 100 stocks. However, if a portfolio of that size is too large for your account balance or if that’s just more stocks than you care to own, a different twist would be to apply a consensus approach. This means focusing on stocks that are held by more than one manager, allowing you to use the best ideas that are shared by numerous managers.
At the end of 2014, WhaleWisdom identified 11 managers that consistently achieved the highest scores from our proprietary WhaleScore measurement. We then created a fund group, “WhaleScore Leaders,” to track them. Using this group as an example illustrates the value of the multi-manager approach (see “Best of the best,” below).
The chart illustrates two hypothetical fund-of-funds replications, both of which significantly outperformed the S&P 500. The first, the Whale Top 5, uses the top five holdings of each of the managers identified in the WhaleScore Leaders to create an equally-weighted portfolio of up to 55 stocks. This portfolio’s five-year annualized return of 22.7% reflects the success of ultra-high-performing stocks such as INCYTE (INCY), a developer of biotech cancer-fighting drugs; Level 3 Communications (LVLT), a network services company; and Breeze-Eastern Corp. (BZC), a safety- and rescue-equipment manufacturer.
A second fund-of-funds replication, the Whale Consensus 20, is an equally-weighted portfolio of the 20 stocks most commonly held by the WhaleScore Leaders in each quarter, within the top 20 holdings of the 11 respective portfolios. Its three-and five-year annualized returns of nearly 31%—even higher than thaose of the Whale Top 5—suggest that a manager’s stock-picking expertise can be validated by the expertise of other top-performing managers.
Savvy investors searching for unique ways to build better investment portfolios would benefit from researching groups of successful managers and implementing ”fund-of-funds” from those groups into their investment portfolios.