First, as we’ve mentioned, hedge funds often hedge by going short other stocks or the overall market in pursuit of absolute returns; they may also pursue more market-neutral strategies such as merger arbitrage or investing in global macro instruments.
Second, the largest hedge fund positions- particularly for successful funds which raise billions in capital from investors- tend to be in large cap stocks almost by necessity. Large caps are more closely followed by large institutional investors and the financial media, and so it is harder to generate alpha in these stocks.
Third, of course, investors in hedge funds pay performance fees. There are other reasons less positive for hedge funds as well- for example, a number of funds have been long gold this year, with disastrous results thus far.
Paying heavy fees to invest in a hedge fund is probably not worth it for most investors who don’t have to concern themselves with finding investment opportunities uncorrelated with the rest of their portfolio (as many institutional investors do). However, on average hedge funds’ consensus small cap picks tend to do quite well.
We believe that there are other strategies waiting to be discovered as well, and of course investors can take advantage of 13Fs and the more up-to-date news from 13D and 13G filings (which occur when a fund or other major investor owns at least 5% of a publicly traded company) to identify free initial investment ideas.
Disclosure: I own no shares of any stocks mentioned in this article.