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Mostly now-illegal or dubious activities are how hedge funds have made almost all of their money in the past 20 years.In the mid to late 90s – investing in tech stocks is the only strategy that worked. So-called “sophisticated” funds like LTCM or Victor Niederhoffer’s fund worked for a while but ultimately failed miserably (in part, because vulture funds picked at their weaknesses until they imploded).
Also, funds that “played the calendar” worked. What is playing the calendar? If you knew XYZ Bank was going to IPO ABC.com you would trade back and forth 10s of thousands of shares, generating commissions for the bank in the month before the IPO. Then, as a token of the bank’s gratitude (or the broker that made the money on the commissions), you would get a slug of 100k shares at IPO time. It would open 50 points higher, you’d sell. REPEAT. Many people made 100s of millions of dollars on this and retired to far-flung locations never to be heard from again. Tech stocks are dead now and playing the calendar is somewhat illegal. Oh, another strategy (now illegal) that worked in the 90s for funds was a loophole called Reg S transactions. But that’s another story.
In 2000-2003 the only strategy that worked was mutual fund timing. Every fund of funds loaded up on mutual fund timers. Now illegal. All the fund of funds redeemed their money from mutual fund timers and had to find a new strategy.
2003-2006 – PIPE strategies consistently outperformed. As well as funds that loaded up on high yield subprime mortgages. 95% of those funds blew up for reasons ranging from the housing bubble imploding to outright fraud. I ran a fund of PIPE funds at the time and fortunately unwound that part of my fund in 2006, dodging the bullet for my investors.
2006-2009 the only strategies/funds that worked were funds that consistently got either insider information or information in a very grey area that could be considered insider but hard to prove. Galleon is the prime suspect but there are many, many others that fell in the grey category. Oh, and if you happened to have been in the 2-3 funds that invested against subprime than you are a hero. Everywhere I go now I seem to run into people who were magically invested in Paulson’s fund. Funny how none of those people seemed invested in Paulson’s fund back in 2007-8 but of well.
Now I think people are struggling to figure out what works. Even the best hedge funds don’t seem to be consistently outperforming the markets (there are outliers but thats normal, a la Taleb’s Fooled by Randomness). Druckemiller and Pelligrini are shutting down their funds for lack of opportunities. The entire nature of funds is changing. I’ll be doing a followup story on what is working now but suffice to say, there’s no magic bullet and there may never be again.
That all said, if you want to simply own the top stocks owned by the most hedge funds, without having to invest in the hedge funds themselves, here are the top 10: courtesy of Goldman Sachs (GS): BAC, MSFT, AAPL, GOOG, JPM, PFE, QCOM, RIG, CVS, V