Recently, investment analytics firm Novus released a report that compiled public portfolio data from the world's largest and most influential hedge funds. Based on that data, we can empirically confirm that hedge funds love these five financial stocks.
Collectively, hedge funds own $33.9 billion in these five stocks alone. That comes to over 836 million individual shares. On average, 141 hedge funds held a long position in each of these five stocks as of the end of the first quarter.
What are these stocks, and why do hedge funds love them? Let's break it down.
The top 5 financial stocks for hedge funds
The first thing you'll notice is that each of these companies is huge. The five are comprised of the four largest bank holding companies and one of the largest insurance companies in the United States.
The sheer size of these financial institutions is most likely the main reason each has such a large interest from hedge funds. Large companies offer the opportunity for funds to invest large sums at one time: Warren Buffett calls this "elephant hunting."
|Stock||Value Owned by Hedge Funds||Number of Hedge Fund Owners||Market Cap|
||$6.65 billion||152||$253 billion|
|Bank of America
||$4.67 billion||148||$183 billion|
||$8.54 billion||146||$173 billion|
|American International Group
||$8.92 billion||125||$82.5 billion|
Don't mistake this huge size for stability though. Each stock has seen new funds buy shares, existing owners sell shares, and others even exit their positions entirely.
In terms of hedge fund ownership, JPMorgan and Bank of America saw the smallest change from the end of last year to the first quarter of this year.
Thirteen hedge funds exited their positions in JPMorgan entirely, but they were replaced by 13 new funds. Twenty-six new hedge funds opened long positions in Bank of America over the same period, one more than the 25 hedge funds that exited.
Of the top five, Wells Fargo and AIG saw the greatest decline in ownership. The number of hedge funds invested in Wells dropped over 8%, driven by 21 funds exiting their positions and only nine new funds buying shares. AIG saw its hedge fund ownership count drop by over 7%.
Citigroup's count dropped by just under 6%.
|Stock||# of New Hedge Fund Owners||Total Hedge Funds Buying Shares||Total Hedge Funds Selling Shares||Total Hedge Funds Holding Their Position||Total Hedge Funds Exiting Entirely|
|Bank of America||26||45||55||22||25|
Why hedge funds do what they do, when they do it
Hedge funds, in their never-ending pursuit of supercharged returns, must optimize each dollar to the highest potential investment. That drives them to sometimes sell great stocks just so they can redeploy capital and profits into the next big opportunity.
It's a high-risk strategy, and it's only possible because of the high-powered analytical teams on staff, the huge sums invested by these funds, and advanced tax strategies out of the reach of everyday investors. With that said, it's next to impossible to determine exactly why hedge funds do what they do, when they do it.
However, each of these financial stocks has a unique narrative that offers insight into the nature of the buying and selling observed here, even if it is just an educated guess.
Breaking down the top five financial stocks owned by hedge funds
Take Wells Fargo as an example. Widely considered the best of the megabanks, Wells reports industry-leading return on equity, return on assets, growth, and efficiency. That strength, however, drives the bank's stock up to a premium valuation making it considerably more expensive than its large bank peers.
The chart below makes it abundantly clear just how expensive Wells is relative to other large financial companies, trading nearly 50% higher than the next highest valuation in this group in terms of price to book value.
That expensive price could be leading many hedge funds to sell shares and take profits, while simultaneously sending new funds to other opportunities with cheaper prices and higher upsides.
Bank of America has a very different narrative, but the conclusion is likely the same. The nation's second biggest bank by assets was hammered during and after the financial crisis. The stock price fell over 83% from the end of the 2007 fourth quarter to the 2009 first quarter. Since that low, the stock has rebounded 155%. It's reasonable that many hedge funds have ridden the rebound and are today taking profits.
AIG and Citigroup both have a similar history to Bank of America since 2007, and this logic could apply just as easily to them as it does to B of A.
JPMorgan, on the other hand, has performed quite well since the financial crisis in financial terms. The bank's profits are tops in the industry as of the first quarter, and its returns on assets and equity are second only to Wells Fargo. Some would argue, myself included, that JPMorgan's stock is currently undervalued. That valuation could be just enough incentive for some firms to buy in today, offsetting those exiting their positions.
Stay focused on the long term
It can be tempting to use the moves made by hedge funds as a template for your own investing. I'd advise you to do your best to avoid this. Hedge funds operate with different objectives than those of us investing for retirement.
The truth of the matter is that we can never really know why these sophisticated funds are buying or selling. Only occasionally will the fund manager release his or her logic to the public. More often than not though, we are just guessing.
Is it fun for investors to follow the moves of these funds? Absolutely. Many of these fund managers are the celebrities of the investing world. However, in terms of making financial decisions for your 401(k) or IRA, you're probably better off applying your own logic that works for your specific long term objectives.
Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of American International Group, Bank of America, Citigroup Inc, JPMorgan Chase, and Wells Fargo. 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.