Hedge Funds' 21 Top Stock Picks

The average hedge fund may be underperforming the broader stock markets for the fifth straight year, but Goldman Sachs’ research department has found that you can outperform the market if you track the most popular stocks held by hedge funds.

The investment bank, like many other market participants, monitors the disclosures of equity holdings that hedge funds have to file every quarter via the Securities and Exchange Commission’s form 13F. It found that its basket of the 20 most concentrated hedge fund stocks has outperformed the S&P 500 by nearly 12 percentage points through August 15 this year. What’s more, Goldman has calculated that since 2001, this strategy has outperformed the S&P 500 benchmark 69 percent of the time by an average of 263 basis points — or about 2.6 percentage points — per quarter. That’s a huge difference.

Meanwhile, Goldman’s VIP basket — that stands for Very Important Positions — of 50 stocks that appear most frequently among the top ten holdings of fundamentally driven hedge fund portfolios has outperformed the S&P 500 by 65 basis points on a quarterly basis since 2001. That adds up to tremendous outperformance on an annual basis.

Through August 15 of this year, the VIP index has beaten the S&P 500 by 46 basis points — rising 20 percent versus 19.5 percent for the benchmark. This basket outperformed by more than 7.2 percentage points in 2012. However, it underperformed by about 5.2 percentage points the previous year.

Goldman also stresses that these strategies work even though hedge funds generally don’t file their mandatory equity disclosures until the last possible day or hour before the deadline — 45 days after the conclusion of the quarter. This is because, contrary to their reputation for being rapid, constant traders, most hedge funds are fairly long-term investors. For the past two quarters, turnover of stocks by hedge funds has been just 30 percent. Turnover among the largest positions in the hedge fund portfolios is only about 17 percent.

Goldman continues to recommend that investors track the hedge fund VIP list, asserting it offers an efficient vehicle for investors seeking to follow the smart money based on 13F filings. It notes that this group of stocks has a large-cap bias with a median market capitalization of $34 billion, compared with $15 billion for the S&P 500.

In the second quarter, 15 stocks ranked among the VIP 500 that were not on the list at the end of the first quarter. The new members are Aetna, BMC Software, Capital One Financial Corp., Cisco Systems, Dell, Dish Network, Johnson & Johnson, Liberty Global Class C, Life Technologies Corp., MBIA, Smithfield Foods, Thermo Fisher Scientific, Valeant Pharmaceuticals International, Wells Fargo and Zoetis.

One stock moved into the top ten list from the first quarter — Charter Communications — replacing Virgin Media, which Liberty Global acquired in June.

Twenty-First Century Fox looks like a new member of the list. However, it is the new name for the television and film assets that were part of News Corp. before the company was divided on June 28. News Corp is now a separate publishing company, ranked near the top of the VIP list last quarter.

The following are the 21 stocks that most frequently appear among the largest ten holdings of hedge funds.