Outsmart Those Hedge Fund Hotshots

Here at the Motley Fool, we spend a fair amount of time poking fun at Wall Street bigwigs for the often odd moves they make. But sometimes, you can learn a lot by comparing your own views with those of Wall Street's finest to see where you're following the herd -- and where you're blazing your own trail.

Hedge funds in particular can seem almost impenetrable to average investors. Typically, you need huge amounts of wealth just to get in the door at hedge funds. Once you're in, don't expect the same free access to your cash that investors in stocks and mutual funds enjoy. Fortunately, we have tools to illuminate hedge funds' inner workings. With the help of the hedge fund tracking service AlphaClone, I decided to take a closer look at what hedge funds are doing with their most popular stocks.

Gauging sentiment
Hedge funds may be secretive, but they can't shut down information entirely. The SEC forces funds managing $100 million or more to disclose their holdings every quarter. That doesn't give anyone real-time information on what hedge funds are doing, because the filings aren't due for six weeks or so after the end of each quarter. But even though the holdings may be out of date the minute the filing goes public, they at least give you some insight into what the pros were thinking recently.

To fully understand how hedge funds invest, though, it's not enough just to look at a single snapshot in time. Instead, you have to see how hedge fund managers' thinking changes from quarter to quarter. That's where AlphaClone's sentiment indicator comes in. By measuring the popularity of particular stocks in the hedge fund community, you can watch certain companies move in and out of favor over time.

Let's examine the stocks with the highest positive sentiment among the 205 hedge funds that AlphaClone tracks:

Source: AlphaClone.

Looking at a collective view makes it impossible to parse the various reasons why each of these more than 200 hedge funds made their decisions about these stocks. But it's easy to speculate on some of the trends these moves show.

On one hand, it's clear that stocks that pay dividends have become increasingly important. Stalwart stocks like Coke, Pfizer, and ExxonMobil have traditionally paid solid, reliable dividends. After a brief spell of cutting their dividends, JPMorgan and Wells Fargo have established plans to restore their yields in the near future. Even Oracle started paying a dividend a couple of years ago, after decades of holding out.

At the same time, though, the supremacy of technology stocks has apparently started to wane. Hedge funds have followed the basic rule of letting their winners ride for the most part, but the minor deterioration in the sentiment score for Apple shows that fund managers aren't afraid to take profits. In addition, managers are clearly losing patience with longtime laggards like Microsoft.

Finally, the rise of traditionally defensive market sectors like consumer goods and health care, and the commodity-sensitive energy sector, suggests hedge funds' increasing desire for diversified portfolios. Financials and tech had some big gains early in the bounce from the market meltdown, but as the rebound gets increasingly choppy, funds are living up to their name, hedging their bets with broader exposure.

What to do
As easy as it is to poke fun at the pros and their lavish 2-and-20 fees, their current strategy makes a fair amount of sense. If you haven't already done so, rebalancing your portfolio to lock in some gains and build a more conservative portfolio could mean the difference between preserving your profits and watching them all go down the drain in the next bear market. Keeping more money? That's always a smart move.

If you really want to be smarter than the hedgies, start by buying the right stocks. We've got five names right here, and while full disclosure obligates us to point out that we already own them, we think you should, too. Click through to read this free special report today.