Where do you find inspiration to discover your next stock investment? One place you can look is in the portfolios of major hedge funds.
In value investor circles, we call value hedge fund managers “gurus.”
It’s quite common for value investors to keep track of what the well-known fund managers are doing – and even replicate some of their trades.
But how do you keep track, and how do you evaluate their investments?
In this blog post, I’ll give you my top five tips for copying the big gurus.
1. Find a List of Hedge Funds with a Value Approach
The funds investing in the U.S. market must report their trades to the U.S. Securities and Exchange Commission (SEC).
This makes it easy for us to look up what they have invested in – at least in U.S. stocks.
The SEC’s own website is not so easy to navigate or search, but there are other websites that collect data and make it more manageable.
You can look the gurus up here:
2. Look at the Number of Companies in the Portfolio
Value investors can be divided into two major groups.
- Quantitative Gurus: these are hedge funds that invest through financial ratios in many companies. We call them hedge funds with a quantitative focus.
- Qualitative Gurus: hedge funds that carefully select companies based on a checklist. We call them hedge funds with a qualitative focus.
We are, of course, interested in the qualitative ones because the companies they have carefully selected are of high quality.
A very rough rule of thumb: if the fund has more than 100 different companies in the portfolio, they are quantitative. But it’s a bit more complicated than that; you should also look at the composition of companies…
3. Look at the Composition in the Portfolio
How much does the guru have in the fund’s largest investment? Value investors with a qualitative approach are not afraid to put a large part of the portfolio into a single company.
As a very rough rule of thumb, a guru with a quantitative focus has a minimum of 10% in a company. However, some value investors set a rule that there must be a maximum of 10% of the fund in a single company, so it’s okay to let it go a bit below 10%.
Here are a few examples of value portfolios with high concentration as of now:
- Warren Buffett: half of his portfolio in Apple
- Buffett’s partner Charlie Munger: 40% in Wells Fargo
- Li Lu: almost a third in Bank of America
4. Look at the Pattern in Their Recent Trades
We always need to assess their recent trades in a larger context.
First, you need to evaluate whether they are sellers or buyers in the current market.
This gives us an idea of their attitude toward the market. What did they do in the last quarter?
Are they selling more stocks than they are buying? Have they done anything at all in the last quarter? Or are they waiting?
5. Research Their Recent Stock Purchases
What is their latest stock purchase? Is it from the last quarter?
Look up the companies. In your initial scan, you should investigate:
1. Did the stock price fall? As a general rule, I avoid companies whose stock price is at an all-time high.
2. Do they make a profit? I avoid companies that are losing money – unless there is a clear explanation of why a particular year is different (such as the COVID-19 pandemic).
3. Are the revenues growing? I avoid companies that are shrinking.
Where do you look this up? For a quick overview, I use MSN Money. It’s free and gives you an 8-year overview (click on Financials after you have looked up the company).
Once you’ve found a company where you can answer yes to all three questions, you can start running them through a proper checklist to ensure that it’s a good investment. You can borrow my checklist here.
This is where the real research begins (and you can learn much more about it in the Value Investor Mastermind).
If you want to learn about how I invest in stocks without fearing a crash, you can download my free e-book Free Yourself here.
