Facebook Inc.’s (FB) stock had a terrible first quarter of 2018, with shares of the social media company plunging by over 17 percent. User privacy became front-page news after questions arose on Facebook’s practices of sharing its user’s data. Despite all the negative headlines, one group of investors took advantages of the fears of others, stepping in and buying shares of the company, in what now looks like a genius move.

The Tiger cubs, a group of hedge funds which trace their origins back to famed investor Julian Robertson of Tiger Global Management, were adding to their positions of Facebook as a group, according to data compiled by WhaleWisdom. As a group, their stake in Facebook grew from a combined portfolio holding of 4.4 percent to a combined 6.38 percent, an increase of 2 percentage points, making it the largest holding for the group.

Holdings Climb

The holdings increased to a combined market value of $5.4 billion, up from $3.8 billion in the fourth-quarter, a rise of 42.1 percent. A move that paid off in a big way, because since the end of the first-quarter shares of Facebook have climbed by 21.4 percent and closed at a record high of $193 on June 2.

Doubling Up

Viking Global nearly doubled its position in Facebook during the first quarter, making it the largest purchaser amongst the Tiger cubs. They upped their holdings by 5.485 million shares, to about 9.35 million in total. Lone Pine wasn’t far behind, adding 3.3 million shares during the quarter, also nearly doubling their previous position, to 7.7 million shares.  Tiger Global, nearly doubled its holdings as well, adding another 2.5 million shares, upping its stake to 4.97 million shares.

Hedge Funds Buying

Hedge Funds, in general, were aggressively buying shares of the stock in the quarter, with the total number of aggregate 13F holdings climbing by 27 percent to 170.48 million shares, from 134.22 million shares in the fourth-quarter. Overall, total institutions upped their holdings to 1.723 billion or about 90 bps.

Analysts Get More Bullish

Despite all the negative headlines, analyst’s views for Facebook have improved since the start of the year. EPS estimates for 2018 have jumped by roughly 12.5 percent to $7.48 per share, while estimates for 2019 have climbed by 8 percent to $8.78 per share. Meanwhile, revenue estimates for 2018 have jumped by 5.7 percent to $56.7 billion, while the outlook for 2019 has improved by 6.6 percent to $71.75 billion.

To some, the period in late March was a time filled with fear, as Facebook’s shares where plunging amongst the uncertainty and potential fallout. However, to others, it created a great buying opportunity, and the Tiger cubs as a group saw the opportunity to buy shares on the fear of others, and it paid off in a big way.

Tesla Inc. (TSLA) is one of the most controversial stories in the stock market in recent history. The electric car manufacturer is led by the CEO Elon Musk, the famed entrepreneur, and creator of companies such as SpaceX and the Boring Co.  It’s an epic bull/bear battle that has ranged since shares rocketed higher in March of 2013. It would seem to be a never-ending battle, while the winner is still undecided. If anything is certain, it is that one side will triumph, and one will be left to swallow their pride and admit defeat.

There is a basic underlying reason why the short-sellers can’t crack the stock, and it comes down to the shareholder base of Tesla with many of the shares being control by just a few very long-term holders, and as long as those holders remain, the shorts may find it hard to win.

Long-Term Holding Base

The top 7 shareholders control just over 60 percent of Tesla shares, owning about 93.6 million, of the 169.79 million shares outstanding. Elon Musk himself owns about 22.5 percent of the total shares, followed by T. Rowe Price with 9.25 percent, and Fidelity which controls about 8.5 percent. Just the top three holders control 40 percent of the shares.

Short Interest Surges

Short Interest has climbed in the shares of Tesla, to a record high, with roughly 38.9 million shares as of May 15. It represents nearly 23 percent of the total shares outstanding. It presents a problem for the short-sellers, because if 60 percent of the shares are in the hand of long-term holders, and there already being 23 percent of the shares, it doesn’t leave many shares available left to sell and push the price lower.

Institutions Adding Shares

During the first-quarter institutional investors increased the number of aggregate 13F shares held by 7.8 percent to 106.15 million from 98.46 million in the fourth-quarter. 92 institutions started new positions, while 256 adding to existing shares. Meanwhile, 97 institutions exited the stock, while 226 reduced their holdings. It is surprising, given the fact shares fell nearly 14 percent during the quarter.

Can Shorts Win?

Short-interest began rising around March 15 and spiked through April 15 and has since plateaued. It isn’t clear at this point if holders of the stock were selling shares, or if it is mostly short-selling related. If the sell-off in Tesla’s stock from the middle of March to present was more short-selling related, then it is going to take the long-term holders to start dumping shares to press prices lower, or else the shorts are going to need to pile in even more.

At this point, the reason why Tesla stock hasn’t fallen apart is that there is a dedicated base of long-term holders, and unless they capitulate it is a game the shorts will likely never win.

By Mark W. Gaffney
For WhaleWisdom.com

Turns out Warren Buffett and Jimmy Buffett are not related. For years the world’s third richest man and the “Margaritaville” singer-songwriter thought they might share ancestors. But DNA testing has apparently ruled that out.

Still, the hedge fund manager and the musician/businessman have things in common. For one, they’re both very rich — though Jimmy Buffett’s estimated $550 million net worth pales in comparison to Warren’s $85 billion.

Another similarity: Both are past their prime when it comes to their main professions — Jimmy Buffett’s creative peak as a songwriter was hit decades ago. Likewise, the performance of Warren Buffett’s Berkshire Hathaway Fund saw its best returns many years back. Both Buffetts’ star status is built on accomplishments from long ago.

That’s how it is with most of the famous hedge fund managers – their reputations as wealth creators are based on returns which occurred when their funds were new and small. With some exceptions, the recent performance of the big-name hedge fund managers has been mediocre.

Nonetheless, investors hang on every word of titans like Buffett, Klarman and Soros, following their media comments intently, and mimicking their portfolios in an effort to profit from their genius.

A popular approach of hedge fund followers is to “clone” the investments of top managers by copying their portfolios. Funds with over $100 million in assets disclose their positions quarterly via 13F filings. While there are some limitations to this strategy, cloning the portfolios of top managers can be very profitable. It gives investors who don’t have millions to invest access to the top ideas of the best hedge fund managers — without paying the hefty fees hedge funds charge.

Here are the ten most popular hedge funds/managers followed by investors at WhaleWisdom.com*:

*based on funds that filed a 1st qtr. 2018 13F

Assets under management (AUM) is the total value of long positions reported in the funds’ 1st quarter 13F filing. Three-year average return reflects the equal-weighted performance of the top 10 stocks held by the fund. If you’d invested equal amounts of money in the top ten holdings of the fund and rebalanced the portfolio quarterly when 13F positions were updated, you would have achieved these returns.

All of the above managers are rock stars in the hedge fund world, famous for creating great wealth for themselves and their investors over the years.

However, here’s a secret that many followers of the hedge fund giants may not realize: Like classic rock stars who had their biggest hits years ago, the famous hedge fund managers’ reputations were built when their multi-billion-dollar hedge funds were younger, smaller and more profitable.

From 2001 through 2006, Warren Buffett’s Berkshire Hathaway Fund returned an average of 11.4% compared to 3.9% total return for the S&P 500. (Based on the equal-weight returns of the fund’s 13F holdings. The actual net returns received by fund investors will be different – probably less due to fees.) Since 2006, Buffett’s annualized return of 7.7% has been pedestrian — about the same as the S&P 500’s total return.

Seth Klarman is another value-investing hedge fund giant. His fund, Baupost Group, averaged a 17.5% 13F-based annual return from 2001 through 2006, trouncing the S&P 500 by 13.6% a year. But since 2006, Baupost Group has averaged 5.9% annually.  The S&P 500’s total return has beaten Klarman’s fund by about 2 percent annually since 2006.

As you can see below, from 2001 to 2006, when Baupost was posting world-beating returns, the fund’s 13F AUM ranged from $650 to $750 million. Since 2009, Baupost’s 13F market value has risen from about $1 billion to over $10 billion as of March 2018.

Baupost Group 13F AUM 2001 to present

Source: WhaleWisdom.com

Declining hedge fund performance as AUM increases is the rule, not the exception. Over the years, many studies have established a correlation between rising fund AUM and diminishing returns. Put another way: Small hedge funds outperform large hedge funds.

Below are the top performing hedge funds over the last three years based on 13F filings. We’ve filtered out funds with less than 10 and more than 200 holdings in their latest 13F.

Source: WhaleWisdom.com

The top performers in the hedge fund universe over the last three years have been small or very small (micro) based on 13F AUM. Only Whale Rock Capital, a mid-sized fund with $2.94 billion in AUM, cracked the top ten.

So why do small hedge funds outperform large hedge funds? Here are a few possible explanations:

Liquidity issues

If you’re a fund manager buying $500K of a moderately liquid stock, you can probably do it easily — without pushing the stock higher. Likewise, when you go to sell, you can likely avoid price “slippage” as you liquidate. As a smaller fund with smaller positions, buying and selling probably has minimal impact on performance.

However, buying $100 million of the same stock is more problematic. Market makers may see your buying and “front run” you, pushing prices higher before you complete the position. On the way out, you can’t just dump all your shares on the market – the stock’s price would plunge. You have to sell the position over days. If you’re not careful, entry and exit inefficiencies can be a major drag on performance.

So as successful hedge funds attract ever more capital, they are forced to gravitate toward large-cap, liquid stocks to efficiently invest their billions of AUM. And highly liquid stocks may not offer the same profit potential as those with less liquidity.

Hierarchy Costs

A manager of a small firm can do much of a fund’s research personally. But as any entrepreneur knows, as a firm grows, a point is reached where the founder can’t do everything herself. Crucial tasks must be delegated. This 2009 study showed that at hedge funds “the number of principals compounds the effects of size on hedge fund performance. Specifically, the alpha spread between small and large funds is almost twice as large for multi-principal funds as it is for single-principal funds.” Large funds must delegate responsibilities to other, possibly less talented analysts, negatively impacting performance.

Skin in the game

When hedge funds start out, most of the capital under management is usually that of the principal(s)/manager(s). If the portfolio does well, the principals do well, their clients do well, and the fund can raise more money. But as AUM gets larger, a greater percent of the principals’ compensation comes from the asset-based management fee. As AUM grows, so does the principals’ incentive to focus on raising more capital versus generating great performance.

Small fund managers tend to have more of their own money invested in the fund. As such they may be more focused on portfolio returns versus raising capital. This study suggests that investors are more likely to earn higher returns by investing in small hedge funds whose managers have more “skin in the game.”

Small Cap stocks

Small hedge funds tend to invest more in companies with smaller capitalizations. While this may result in greater volatility of returns, on balance small cap stocks tend to outperform large caps. This so called “Small Firm Anomaly” may help explain small hedge fund outperformance.

Why do small stocks outperform?

Small public companies often have little or no analyst coverage, and so may have unknown potential. Smaller companies have greater growth potential than large companies: A tiny public company can triple its revenues with one contract — that’s not going to happen to Apple Computer. Likewise, when small firms fix problems, the resulting improvement in profits can drive big price gains. Small cap stocks also tend to have lower stock prices, resulting in greater price appreciation compared to big firms with higher prices.

For talented managers, the small-cap sector may offer greater opportunity to apply their skills at finding emerging and undervalued companies.

So, Jimmy Buffett isn’t writing hits like “Margaritaville” anymore; and Warren Buffett isn’t generating returns like Berkshire Hathaway had back in the day. They’re still good at what they do and have more fans than ever.

But if you’re looking for stellar returns by following the leading hedge funds with the best ideas, you’ll likely make more money studying the moves of the small fund managers, the ones who aren’t famous. Yet.

Qualcomm Inc. (QCOM) has been in the news a lot lately, but not for good reasons. In late 2017 Qualcomm was targeted by Broadcom Ltd. (AVGO) in a takeover attempt, which was later blocked by the US Government. Lately, its stock has become a barometer tied to the trade tensions between the US and China. Qualcomm is still waiting to get a final approval from regulators in China for its $44 billion acquisition of NXP Semiconductors NV (NXPI).

All the negative headlines have not deterred investors, in fact, the stock was among the top 10 on the WhaleWisdom 13F Heatmap. The high ranking makes it one of the hottest stocks amongst institutional investors during the first-quarter.

(WhaleWisdom)

Rotation Among Holders

There appeared to be a rotation among the shareholder base, with only a minor change in the aggregate 13F shares. At the end of the first quarter, the aggregate 13F shares fell by 1.87 percent to 1.14 billion from 1.161 billion in the fourth quarter. In total 106 institutions created new positions in the stock, while 514 added to holdings. Meanwhile, 150 institutions exited the stock, while 651 reduced their stakes.

Dim Prospects

The outlook for Qualcomm doesn’t look particularly attractive over the short-term, which has to make one wonder why investors would be so hot on the stock during the quarter.  Analysts are forecasting earnings to fall by over 23 percent to $3.29 per share, while revenue is expected to drop by 5.5 percent to $21.97 billion, its lowest revenue reading since 2012. Revenue peaked at $26.5 billion in 2014, and could decline by 17 percent should analyst estimates prove to be correct.

Not Even a Bargain

Shares of the stock aren’t even cheap trading at almost 15 times 2019 earnings estimates of $3.81 per share. That one-year forward earnings multiple is on the upper end of its historical PE ratio over the past three years.

Analysts Lukewarm

Even the analysts appear to have questions on Qualcomm, with a heavily reduced average analysts price target of $63, about 11 percent higher than the stocks current price around $57.70. However,  that average is down by about 12 percent from roughly $72 in the middle of March. Of the 25 analysts covering the stock, only 48 percent rate shares a “buy” or “outperform,” while 44 percent have a “hold” rating, not an overwhelmingly bullish endorsement.

A Bet on the Future

It may simply be a bet on the prospects for Qualcomm should it be able to finally close its deal of NXP Semiconductors, after waiting for over one-and-a-half years. The combined company would have a much more diversified portfolio and be better positioned for future growth in autonomous driving, artificial intelligence, near field communication, and the rollout of the next generation in wireless technology, 5G. Perhaps with shares down by nearly 16 percent so far in 2018, some investors viewed the pullback as an opportunity to pick up shares.

We will never know for sure, what the motivation for investors were during the first quarter, but it seems clear it must be for the future of the business because the current prospect looks pretty dismal.

By Mark W. Gaffney
For WhaleWisdom.com

“Don’t tell me what you think, just tell me what’s in your portfolio.”

Nassim Taleb in Skin in the Game

In his most recent book Skin in the Game, Nassim Taleb asserts that if you offer an opinion, and someone follows it, you are morally obligated to share in the consequences. If you profit from giving advice, you should also share in the loss if your advice turns out to be bad.

The book is essentially about who to trust and who not to trust. Taleb thinks you should trust those who have skin in the game — advice givers who are exposed to both reward and risk. Be wary of armchair experts who offer grand opinions but won’t suffer if they’re wrong: “Do not pay attention to what people say, only what they do, and to how much of their necks they are putting on the line,” Taleb writes.

What if everyone giving investment advice — financial advisers, brokerage firm analysts, talking heads on CNBC — were required to show their portfolios when making recommendations?

A rule requiring advice-givers to disclose their portfolios would definitely simplify the financial sales process: Skip the spiel Mr. Financial Salesman, just show us what you’ve been buying and selling. When the hedge fund expert appears on TV raving about a hot stock, a list of his personal holdings would be displayed on the screen below his face.

One of the best ways to profit from experts who have skin in the game is by following the public filings of corporate insiders — legal insider trading.

If financial advice givers disclosed their portfolios, it would elevate our confidence in their recommendations.  There’s something else it would do: It would put out of business financial gurus, market prognosticators, and securities analysts that don’t follow their own advice, that don’t “eat their own cooking.”

Unfortunately, such a law isn’t likely to happen.  Nonetheless, seeking out experts who have proven skin in the game makes good sense. But who among the various analysts and stock pickers we rely on for investment ideas are practicing what they preach?

One of the best ways to profit from the actions of experts with demonstrated skin in the game is by following the public disclosures of corporate insiders — legal inside traders.

Any officer, director or 10%+ owner of a public company is considered an insider by the SEC. Any transaction by a corporate insider must be disclosed via a SEC Form 4 filing within two business days of the insider’s trade.

If you’d rather pay attention to what financial experts do, and not what they say, Form 4 filings are about as good as it gets.

Corporate insiders, particularly “C-level” officers, have access to information regarding their own companies not available to the general public. Information that, if acted upon, could be highly profitable.

Certainly, it is illegal to trade on non-public material information. For instance, if the CEO of company XYZ knows that 4th quarter earnings are going to be spectacular, she cannot buy XYZ stock immediately before the earnings announcement.

However, U.S. insider trading rules are unclear at best. There is so much ambiguity and complexity surrounding insider trading law that a book on the subject could be entitled “100 shades of grey.”

If you’d rather pay attention to what financial experts do, and not what they say, Form 4 filings are about as good as it gets.

Decades of academic research confirms that corporate insiders as a group achieve market-beating profits. Many individual insiders have stellar trading histories. How much of this outperformance is from being smart people who know their industries, and how much is from exploiting the grey areas of insider trading law? It’s difficult to say. Whatever the case, insiders consistently beat the market and few are charged with insider trading. In 2017, the SEC accused 41 people of insider trading; of those, only a small number were officers or directors of public companies. Meanwhile there were tens of thousands of Form 4s filed last year.

One of the best skin in the game trades to follow is when a long-term officer or director, or better yet the CEO/founder of a company, makes an unusually aggressive purchase of his or her company’s shares.

Here’s an example:

On February 26 of 2018, Bryan Sheffield, President, CEO and Founder of Parsley Energy (NYSE: PE) bought 189,500 of his company’s stock at $26.34.  That’s a $5 million purchase. A review of Sheffield’s past Form 4 filings shows that since May of 2014, when PE began trading, Sheffield had never purchased a single share of his company’s stock on the open market.

Source: WhaleWisdom.com

Parsley Energy had traded between $11 and $40 since 2014. At no time did Sheffield feel inclined to buy PE shares — his Form 4 filings reveal only granted shares, exercised stock options and stock sales. Why would he suddenly pony up $5 million to buy his own stock on the open market? There’s likely only one basic reason: He believed the stock was going higher and he’d make money.

The beauty of following insider trading and significant “skin in the game” trades is that you don’t really need to know why the insider is buying. The fact that the insider is risking a big chunk of his or her own capital speaks for itself. That’s not to say you shouldn’t do research after seeing a significant insider buy, you should. But an insider, an expert on his company, buying significant shares on the open market is a reason to get very interested. The insider is not telling you to buy his stock, but rather putting his money where his mouth is.

Now you might argue that Sheffield is a rich man, and $5 million to him isn’t necessarily that big of a deal. After all, the 189,500 shares purchased represents less than 1% of his total holdings. Maybe $5 million to him is like $5,000 to most of us. Possibly a lower level corporate officer buying $200,000 of her company’s stock — the equivalent of her annual salary — is a better sign of skin in the game.

The trick of trading off the Form 4 filings of insiders is to decipher which buys (sells are usually not predictive) represent an insider putting significant skin in the game, and which buys are insignificant or b.s. trades — the insider giving the appearance of supporting his or her stock.

Of course, there is no guarantee that investing alongside an insider will be profitable. Corporate insiders are sometimes wrong, and they’re often early. And instances where insiders “back up the truck” and buy their own shares are rare. But watching and waiting for high conviction buys by corporate insiders is worth it. There is no better place to get investment ideas from experts with proven skin in the game.