Blue chip stocks, thanks to their massive market capitalizations and deep liquidity, are a natural home for hedge funds and other large pools of institutional capital. And since hedge funds are the putative smart money, who wouldn't want to know which blue chip stocks they're chasing with their capital?
True, hedge funds collectively have a rather poor long-term track record vs the broader market. It should also go without saying that not all blue chip stocks are created equal.
Yet there's still something irresistible about knowing what hedge funds have been up to. And even if the industry tends to generate disappointing returns, you've got to give it credit when credit is due.
Big-time investors are willing to pay up for complicated strategies offering exposure to uncorrelated assets. So it's not necessarily possible to tell from the outside if a hedge fund is providing its clients with the performance they expect.
It's also important to know that hedging strategies by definition limit upside when stocks are rising. That helps explain the industry's tendency to underperform in a bull market.
By the same token, however, hedging strategies limit downside when everything is selling off. And goodness knows investors saw plenty of red on their screens just a couple of years ago.
"Despite the challenges from a bear market, hedge funds delivered resilient performance in 2022," notes Barclays Capital Solutions. "In a year when the MSCI World Index fell 18%, hedge funds captured only a fraction of the drawdown, thus offering the best downside protection since the dot-com bubble burst."
Blue chip stocks: timing is everything
It's been something of the same old story for hedge funds since the bull market took off. Equities are on fire – and hedge funds are back to their old underperforming ways.
The Eurekahedge Hedge Fund Index delivered a total return (price change plus dividends) of 7.7% for the year to date ended October 31. The S&P 500, by comparison, generated a total return of 21% over the same span.
So why are hedge funds lagging? As noted above, hedging strategies can limit upside in rising markets. That doesn't let hedge funds off the hook entirely, however. A look at changes in their holdings can offer some insights too.
We won't know how hedge funds are dealing with the current market environment until they disclose their fourth quarter buys and sells in mid-February. But we do know what they were up to in Q3 thanks to a recent batch of regulatory filings.
As usual, hedge funds were heavily invested in most of the market's biggest and bluest of blue chip stocks – particularly Dow Jones stocks. Indeed, 11 of the 21 names listed below are components of the blue-chip barometer.
That's partly a function of Dow stocks' massive market caps and attendant liquidity, which, as noted, provide ample room for institutional investors to build or pare large stakes. Big-name blue chip stocks also carry lower levels of reputational risk for professional money managers. It's a lot easier to justify holding a large stake in a Dow stock than a no-name small cap if restive clients start grumbling about their returns.
What's interesting about the latest data is how hedge funds collectively reduced exposure to almost all of their top holdings during the third quarter.
For example, Nvidia (NVDA), which was added to the Dow Jones in November, and Amazon.com (AMZN) saw heavy net selling of their shares.
That may not have been ideal timing. Indeed, only three of hedge funds' top stock picks saw an increase in net share ownership, as readers can see in the table below.
In other changes, Chevron (CVX), Walt Disney (DIS) and Walmart (WMT) fell off the list this month, while Costco (COST), Taiwan Semiconductor Manufacturing (TSM) and Bank of America (BAC) joined the club.
But enough with the armchair quarterbacking. Have a look at the chart below to see hedge funds' 21 top blue chip stock picks as of the end of Q3.
Source: WhaleWisdom and the Securities and Exchange Commission.
