Ascribing the title of "best" to anything is a bit subjective, particularly hedge funds. After all, many hedge funds are the "best" for different reasons. Some are the best at generating total returns, others are the "best" for generating consistently positive performance, in good and bad markets.
I define the best hedge funds as those that have performed strongly for long periods of time, and have continued to perform well, even as their asset size grows. I also attribute some "style points" to hedge fund managers that are in many ways professors of their craft, capable of explaining their investing style to ordinary investors like you and me.
With these criteria in mind, let's look at three of the best hedge funds based on their historical performance and influence in the stock market today.
1. Greenlight Capital
There are few investors who are as broadly respected as David Einhorn. He started his first fund in 1996, delivering annualized returns of 18.9% for his investors, after fees. Thus, each dollar invested at inception would have been worth $24.16 at the end of 2014, well in excess of the general stock market return.
Einhorn's record is more impressive when you consider that he runs a long-short fund, which requires the incredible ability of buying great stocks and shorting bad stocks. Greenlight has done well in long and short positions alike. His most notable short positions include the likes of fallen companies Allied Capital, Lehman Brothers, and Conseco.
Einhorn's record makes him one of the most influential investors in the market today. His mere appearance on a company's conference call can send a stock flying or falling in after-hours trading. And he is incredibly open about his positions, detailing in his letters to his clients his biggest investments complete with a short thesis for why he's buying or selling. These letters are frequently published online, and worthy reading for anyone interested in the stock market.
2. Pershing Square
Despite a few high profile missteps, Bill Ackman is still a legendary hedge fund manager. Pershing Square's oldest fund generated compounded returns of 23% over 11 years, turning $1 into just under $10 as of 2014.
Bill Ackman describes himself and his firm as an activist investor, taking large stakes in publicly traded businesses to push for changes to create a higher share price. Notable victories include Canadian Pacific Railway, a contest in which he pushed for replacing management to improve operating performance. Shortly thereafter, profits reached records, and Ackman delivered an excellent return for his investors.
Like Einhorn, Ackman's investments are documented in his quarterly letters to investors, complete with brief investment cases for each of his largest positions. Widely followed, Ackman remains a very influential investor, with his influence only becoming larger with the size of his fund. He recently teamed up with one publicly traded biotech firm to pursue the acquisition of another, in what was a first time event for the industry. Publicly traded firms rarely, if ever, team up with an activist in the pursuit of an acquisition target, a tip of the hat to Ackman's ability to force changes in his portfolio companies.
3. Baupost Group
Seth Klarman of Baupost Group has a cult-like following hedge fund managers dream of. His 1991 book on investing, Margin of Safety, which once sold for $25 on the shelves of bookstores, sells for more than $1,000 on Amazon. His performance has reportedly topped 17% per year since Baupost's inception in 1982.
Baupost's returns are more impressive when you consider that Klarman has a particular love for keeping a big portion of his funds in cash. In 2013, the firm reportedly held nearly half its assets in cash, as Klarman said that he wasn't finding any particularly attractive investment opportunities.
In an industry where many judge themselves based on the amount of assets they manage, Klarman has been a good steward of his investors' capital. When his ideas are thin, he's forcefully returned money to his investors, not wanting to sacrifice returns for size. He's also a fan of concentration, often stating that he'd prefer to own 10-15 companies he knows very well than a wide swath of stocks he understands little about. His funds' above-average cash cushion tends to reduce some of the volatility that typically comes with a more-concentrated fund.
As for managers to watch, Klarman is certainly one. He publishes his investments like the others, writing frequent letters to investors with commentary and criticism on wide-ranging topics from individual stocks to Federal Reserve policy. An outspoken investor, his record suggests he's an investor worth listening to.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.