Every once in a while, following the crowd proves to be a lucrative strategy.
That’s especially true when the crowd is a pack of hedge fund managers who have been beating the market in a year when it feels like the best thing to do is sit on the sidelines.
So far in 2019, this group of hedge funds has beaten the S&P 500 by 3 percentage points.
And just how have they been doing that? By investing in some of the market’s most-loved stocks.
“Despite the strong track record of popular hedge fund stocks, investors often view high ownership as a negative trait when evaluating stock prospects. Clients often ask us to include hedge fund ownership data in stock screens, expressing a preference for buying ‘under-owned’ stocks,” Goldman Sachs (NYSE: GS) strategist Ben Snider wrote in a report for clients. “In fact, during the past decade hedge fund popularity has been a more useful criterion for selecting stocks than valuations.”
Looking at 855 hedge funds—whose assets total $2.1 trillion—Goldman found that the funds have returned 8% year-to-date. But in looking at those stocks that are the most popular among funds, Goldman found that they have returned 18%, handily beating the S&P’s return of 15%.
But what’s even more interesting, Goldman found that since 2001, stocks with a place in the top 10 portfolio positions have beaten the S&P 61% of the time. And those funds that hold the most shares of those stocks have beaten the market 63% of the time.
“The signals from hedge fund popularity and valuation have been particularly useful in combination, especially for investors with slightly longer investment horizons,” Snider wrote. “During the past decade, popular stocks have generally outperformed unpopular stocks across both 3- and 12-month investment horizons.”
At a time when hedge funds are being criticized for high fees and underwhelming returns, Goldman makes the case that it’s smart to pay attention to what these funds are investing in and following the crowd, at least where the most popular stocks are concerned.