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Why You Should Buy Hedge Funds' 5 Favorite Stocks

Williams Partners

You'd be forgiven for thinking that natural gas pipeline owner Williams Partners (WPZ) is a commodity-driven stock. It certainly seems like one at first glance. But while this master limited partnership owns one of the largest midstream natural gas operations in the country, it's not a commodity-driven play. It's an income play.

Williams owns one of the largest pipeline networks in the country, transporting natgas in huge volumes. It also operates a huge midstream operation that gathers and processes natgas with a focus on the lucrative Marcellus shale. But more than three-quarters of WPZ's cash comes from fee-based sources that aren't subject to swings in commodity prices (the firm makes most of its money by charging customers to transport their gas). That, and the tax advantages of a MLP, mean that this stock was basically purpose-built for building income. And a huge 7.05% dividend yield proves it.

After spending several years in acquisition mode, Williams owns a mature portfolio of assets that should continue to pay off in the years to come. Hedge funds made a big bet on WPZ, buying up 6.22 million shares in the most recent quarter. Collectively, that entitles funds to a $62 million dividend payout in the year ahead.

Starwood Property Trust

Clearly, hedge fund managers have income generation on their minds right now. That's the only explanation for their stakes in another super-high yield name this quarter: Starwood Property Trust (STWD). Funds picked up 13.5 million shares of the commercial mortgage REIT, mounting up a $504 million stake. Currently, STWD pays out a 7.07% yield.

Starwood invests in mortgage debt, earning the spread between their cost of capital (through either debt or equity offerings) and what they're able to collect from borrowers. The real secret to the mortgage REIT model is leverage; by taking on relatively low-risk assets (like agency backed securities), STWD can lever up its balance sheet dramatically without ramping up risk nearly as much. That's how the firm can pay out such a large yield to its investors.

As a real estate investment trust, STWD pays out around 90% of its income directly to shareholders without being subjected to corporate income taxes -- that makes it a purpose-built income-generation machine. A recently announced plan to spin off its residential landlord unit into a new publicly traded REIT called Starwood Waypoint Residential Trust. The move should unlock some extra value for shareholders, especially in the accommodative REIT IPO market we're seeing this year.

If you're looking for income exposure right now, you could do a lot worse than to follow hedge funds into STWD.

To see these stocks in action, check out the Winter 2013 Institutional Buys portfolio on Stockpickr.



-- Written by Jonas Elmerraji in Baltimore.

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Follow Stockpickr on Twitter and become a fan on Facebook.

At the time of publication, author was long AAPL.

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.

Follow Jonas on Twitter @JonasElmerraji

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes, Investor's Business Daily and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation. Follow Jonas on Twitter @JonasElmerraji.
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