Every quarter Insider Monkey publishes its list of best performing hedge funds. Our goal is to identify the best hedge funds to replicate and thus avoid large hedge fund fees. I am going to explain this point a little bit later. First, last quarter's best hedge fund: Noked Capital.
Noked Capital is an Israeli hedge fund that usually invests in Israel based stocks globally. However, they also have a small global equity fund that also invests in US stocks. According to their site "Noked Global Equity, is a long bias global equity fund focusing on investing in global shares and aspires to achieve overperformance in relation to the MSCI AC Index, without increasing the level of risk over time. The portfolio is characterized by sectoral and geographical diversification."
Roy Vermus and Shlomi Bracha founded Noked Capital in November 2013 and turned it one of Israel's biggest hedge funds. According to our calculations Noked Capital's 13F positions in stocks with at least $1 billion in market cap returned 16.4% during Q3 and outperformed the S&P 500 Index by nearly 15 percentage points. It was the best performing hedge fund tracked by Insider Monkey.
We continuously track the performance of each hedge fund's 13F stock picks because we can't rely on their actual returns. Most hedge funds are 40-70% net long, which means their betas are in the neighborhood of 0.4 to 0.7. When the entire market goes up 28%, these hedge funds go up about 40% to 70% of this figure just because they are long the market. This has nothing to do with their stock picking skills. Yet, most of these hedge funds still charge 2% of their clients' assets and 20% of their returns as fees. That's why almost everybody hates them. This is probably the biggest travesty in the financial markets. Some hedge fund managers became billionaires because they discovered a legal way of cheating investors out of their savings. Most investors are (most likely unknowingly) invested in hedge funds through their pension funds, state or local governments, or labor unions.
A generation ago, there weren't a lot of hedge funds, and hedge funds generated amazing returns. Investing got harder and harder over time, and the number of truly talented hedge fund managers declined, yet the total number of hedge funds skyrocketed. Nowadays, most hedge fund managers can't generate any alpha, yet manage to thrive because their investors are truly dumb. Let's do a little bit of math (not too complicated, 5th grade level math) and explain how hedge funds are able to manage to trick their gullible investors.
In 2019, S&P 500 Index returned about 28%. If you are an untalented hedge fund manager (untalented in investing, but of course you had to be extremely talented at marketing in order to raise billions of dollars from gullible pension funds, labor unions, and state and local retirement funds), you'd be 40-70% net long the market. This means without lifting a finger you'd generate 11.2% (40% of market's 28% gain) to 19.6% (70% of market's 28% gain) in gross returns. But since you are such a "gifted" hedge fund manager, you get to charge your clients a flat fee of 2 percentage points of their total assets and another 20% of their gains. Twenty percent of 11.2% is another 2.24% in performance fees and twenty percent of 19.6% is 3.92%. So, your total take away in fees is 4.24 percentage points at the low end and 5.92% at the high end for being such a "brilliant" hedge fund manager in fees. That means your investors' net returns would be anywhere from 6.96% (11.2% - 4.24%) to 13.68% (19.6% - 5.92%).
According to HFR, equity hedge funds returned an average of 10.24% in 2019. That's the mid point of our estimated 6.96% - 13.68% range for the returns of untalented hedge fund managers. Unbelievable!!! Don't you agree?
That pretty much proves our point that most hedge fund managers aren't skilled investors. They are waaaaaaaaaaaaay too expensive. So, stay away from them. It doesn't make sense to pay 4% to 6% of your assets every year to invest in a hedge fund because most of them won't generate 10-20 percentage points of outperformance to DESERVE these sky-high fees.
At Insider Monkey we basically do two things. First, we get rid of ALL of these hedge fund fees, assuming that you aren't one of our premium members who pay a few hundred dollars annually for our newsletters. Second, we do a pretty good job of identifying talented hedge fund managers. We have been publishing thousands of articles and sharing with investors the performance of the top 20 stocks among hedge funds (click for Q3 rankings and see the video below for Q2 rankings). Video: Click the image to watch our video about the top 5 most popular hedge fund stocks.
These stocks returned 37.4% during the first 11 months of 2019 and BEAT THE MARKET BY 9.9 PERCENTAGE POINTS. This is our gift to you. We don't charge a dime for it, just click the link above and see the list of hedge funds' top 20 stock picks yourself. Interestingly, the stocks in this list don't change very frequently either. The top 5 stocks at the end of September are the same 5 stocks at the end of June. You don't have to trade in and out of stocks very frequently, and trading fees are zero nowadays anyway. Do yourself a favor and try investing at least a small portion of your portfolio in hedge funds' top 20 stocks and subscribe to our free newsletter below to get our quarterly updates listing the changes:
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Back to Noked Capital. It is too early to determine whether Noked Capital is one of the truly talented hedge funds. It kind of landed in the #1 spot in our 2019Q3 rankings by luck. Noked Capital's main hedge fund invests Israel based companies and most of these stocks trade in Tel Aviv. However, some Israeli companies trade in United States. Noked Capital probably had a regular sized position in one of these companies: SolarEdge Technologies, Inc. (NASDAQ:SEDG). They had $42 million invested in this company at the end of September.
Noked Capital's stock positions in non-Israeli companies were very small relative to its SolarEdge position but that's not because it likes Solaredge 40 times better than American stocks. That's probably because its global equity hedge fund's AUM was much smaller than its flagship hedge fund that only invests in Israeli stocks. In its 13F filing Noked Capital lumped its Solaredge position together with its other positions in its global equity fund. As a result, it looks like Noked Capital is allocating 44% of its 13F portfolio to SolarEdge whereas its positions in companies like Delek US Holdings, Inc. (NYSE:DK), Apple Inc (NASDAQ:AAPL), and Merck & Co., Inc. (NYSE:MRK) get a much smaller weighting in our calculations.
SolarEdge went up from $62 at the end of June to $82 at the end of September. Since its weight in the portfolio was 44%, this explains 14 percentage points of its 16% return in Q3. Heading into Q3 some of Noked Capital's biggest positions also counted stocks like Facebook, Inc. (NASDAQ:FB) and Alphabet Inc. (NASDAQ:GOOGL). Facebook Inc. didn't perform well during the quarter, but Alphabet Inc. did. Overall though, the rest of Noked Capital's stock picks generated an average return of close to 4% and outperformed the market. However, the outperformance margin of the rest of Noked Capital's 13F portfolio isn't enough to put it at the top of our rankings. So far, Noked Capital looks like a one trick pony that won't make the top of our rankings in Q4 or later. Its positions are mostly in large-cap US stocks and the main purpose of these positions is to provide mostly beta exposure to US stocks with a little bit of alpha generation capacity.
Disclosure: None. This article is originally published at Insider Monkey.