Many strategies utilized by hedge funds are above and beyond the average investor – from leveraged positions to trading derivatives – all with the goal of generating astronomical returns. But do these institutional investors really have an edge?
[Read more from Kapitall: Revisiting Outperforming Stocks as More Money Flows From Bonds to Equities]
As Bloomberg helpfully points out, hedge funds are meant to create 'alpha' – "risk-adjusted returns that surpass the overall market because of the skill of the investor" – something they have failed to achieve in reality this year. The average hedge fund performance this year has fallen behind the Standard & Poor's 500 index by about 10%.
And as detailed in The Atlantic, on average institutional investors have returned 17% since 01/01/2003. Compare this to a simple 60-40 equity-bond index fund, which over the same period would have returned 90%, and hedge funds don't look so appealing.So should the average investor look to hedge funds for inspiration? Returns vary among different institutional funds, and some may have a different focus or time frame. We decided to look closely at institutional selling, that is, which stocks are funds not holding on to in their portfolios. We began with a screen for companies with significant net institutional sell-off over the last quarter representing at least 5% of share float. This indicates that institutional investors such as hedge fund managers and mutual fund managers expect these stocks to underperform despite any potential upside. Next we looked for a possible fundamental catalysts, which might have lead to this negative sentiment. At the same time, we wanted to run a screen that is accessible to the average investor – who might well be considering these companies without paying attention to the actions of hedge funds. We looked closer at the performance of the stocks in our results, screening for those that have highly underperformed over the last quarter – with change in price worse than -30%.