How to create a hedge fund portfolio that beats the market (checklist)
In Tradestream your Way to Profits, I wrote about how smart investors can use hedge fund filings to create a wining portfolio. By tracking the holding information of some of the most successful investors on the planet, individual investors can piggyback on hedge fund returns. Many in the media -- including some people I believe are smart, intelligent investors -- poke holes in these replication strategies. I'm not sure of their motivations, but the data are clear: By methodically creating a portfolio that seeks to mimic specific hedge funds (not all are good candidates for replication), individual investors get a big piece of the returns many of these funds have generated for years. Here's a webinar I hosed last year on the subject of cloning hedge funds.
My 'hedge fund' portfolioI've been developing a Tradestreaming.com Guru Portfolio this for the past couple of years (testing for 1 and using it with client funds for 2). While the S&P 500 was essentially flat last year, my Guru Portfolio generated close to 6% before fees. Even more impressive, it's up close to 190.3% over the past 3 years with a 13.4% drawdown. AlphaClone has been indispensable to building this portfolio (that image is from AlphaClone). I wrote about how AlphaClone is the cure to investor insanity in 2009 and I still believe it's a very important tool for all investors to build tested, defined strategies that build on the research done at the world's top hedge funds. The point here though is that just buying a stock willynilly that Carl Icahn is targeting on a buyout or that Warren Buffett just put $1B into, isn't really a strategy. For hedge fund replication to really work, you need to spend the time understanding how certain funds can best be piggybacked. There needs to be a method to the strategy for this to really work -- one that removes and individual's decision making (ah, I like this stock OR, nah, I wouldn't buy that -- it's a dog!) throughout the process. I found this to be the hardest part of implementing this quasi-quantitative strategy.
How to build a custom piggybacked hedge fund portfolioThere are simpler strategies on AlphaClone that are just plug-and-play, no research needed. You can see 6 different ways people are tracking hedge funds which don't require a ton of work. Some of these work amazingly well, but I personally wanted something customized to some of the things I'm working on at Tradestreaming. Here's how I built my Tradestreaming Guru portfolio and how you can begin doing it in just under 1 hour with AlphaClone. 1. Understand how funds can be tracked: Some funds are hard to replicate. From what I've seen the best funds to piggyback hold positions for at least a few months at a time, have a value approach, and don't have a problem taking big swings on individual stocks (meaning, have a sizeable % of their assets in individual names). *Important point: Sometimes (and AC helps here, too), it's not an individual fund's picks that are the most exciting. Instead, it's the most popular stocks held by a family of funds (say, the Tiger Cubs). Or, the most popular (that's its technical name) stock in a certain industry or market cap held by all hedge funds (say, technology or transportation). Here's a list of the most tracked funds on AC to get you started (though AlphaClone literally tracks thousands of funds): 2. Determine what your ideal portfolio looks like: If you look at the list above, these funds perform pretty damn well (at least at the 3Y mark), but their clones are portfolios comprised of the funds' top 10 holdings. If you tracked a handful of these funds, you'll end up with a pretty large portfolio of individual stocks. Before you begin, it's important to envision what type of portfolio you want:
- Do you want to design a portfolio of 100 positions or 10?
- Are you comfortable following picks from just one hedge fund or do you want more diversity?
- performed well
- had high Sharpe ratios
- lower drawdowns
- I looked for returns over 3 to 5 years
- and that replicated well by using a single stock pick to represent their returns