Our flagship small-cap hedge fund strategy returned 131.4% in its first 2.5 years, vs. 57.2% gain for the S&P 500 index ETF (SPY) during the same period. Our stock picks also managed to outperform the S&P 500 index by more than 10 percentage points in each of 2012, 2013, and 2014. Our monthly returns are presented below.
We aren’t one of those slimy newsletter marketers who try to part mom-and-pop investors from their hard earned dollars by touting the incredible returns of SOME of their recommendations. The majority of active fund managers can’t beat the market after taking into account the fees they charge. In fact, the majority of investment professionals you come across can’t beat the market. If beating the market is so darn difficult, how did we do it?
Our research director has a Ph.D. in financial economics and he has been doing quantitative stock research for more than a decade. This doesn’t guarantee that he can beat the market but it means that he can at least do high quality research and understand the research done by other academics.
He analyzed the quarterly 13F filings made by almost all of the active and dead hedge funds covering the 10-year period between 1999 and 2009. His research revealed that ordinary investors could have outperformed the S&P 500 index by 18 percentage points per year during this 10 year period by imitating certain hedge fund stock picks. The stock market was flat during this 10 year period, yet our strategy returned an average of 18% per year.
Our thesis is very simple. Hedge funds are strongly incentivized to outperform the market. Some hedge fund managers make billions of dollars in a single year if they generate decent returns. They hire the smartest students graduating from the best universities in the world. They hire those students’ professors. They hire the top experts and consultants in the
field to gain just a tiny edge over other investors – including you. And sometimes they cheat and get their hands on illegal inside information. However, we think that hedge funds are more likely to get an edge over ordinary investors in small-cap stocks because these stocks aren’t well-covered and well-researched by a lot of investors. So, we formed our thesis:
When several hedge fund managers buy the same small-cap stocks, those small-cap stocks should outperform the market on average.
This is a very simple and intuitive thesis. Think about it. If hedge funds can’t beat the market by picking under-researched small-cap stocks, they sure can’t beat the market by picking large cap stocks that are followed by everyone.
We weren’t surprised that hedge funds’ most popular small-cap stock picks outperformed the market by 18 percentage points.
However, this is only the first step. The real test is measuring the performance of this strategy in real life. There are a lot of strategies that worked in the past that don’t work anymore.
We launched our quarterly newsletter at the end of August 2012 and started sharing the stock picks of our small-cap hedge fund strategy with our premium subscribers. In its first year our small-cap strategy’s stock picks returned 47.6% and beat the S&P 500 index by more than 29 percentage points. In its second year our strategy’s stock picks returned 35.8% and beat the S&P 500 index by more than 10 percentage points. Since its inception at the end of August 2012, this strategy returned 100.4% through the end of August 2014. Our strategy kept beating the market since August 2014 as well. Overall, our picks returned 131.4% through the end of February 2015, vs. 57.2% gain for the S&P 500 ETF (SPY). If you have been investing in Vanguard’s or Fidelity’s S&P 500 index funds, you are 74 percentage points behind our subscribers.