Constructing the Perfect Hedge Fund ETF
Soroush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In the financial world, hedge funds are investment vehicles limited to the affluent – typically those who have at least $1 million available to devote. Unfortunately, this means that the majority of investors are unable to employ the services of some of the greatest money managers of our time, from Warren Buffett to Bruce Berkowitz. While individuals can imitate the various strategies of the most successful funds (read here for more), this type of approach requires active management and a good amount of research.
To solve this problem, a variety of hedge fund ETFs have been created by Wall Street’s financial wizards, which essentially mimic the buying behavior of the hedge fund industry as a whole. Some of the most popular include the IQ Hedge Multi-Strategy Tracker, WisdomTree Managed Futures Strategy Fund, Credit Suisse Merger Arbitrage Liquid Index, and the ProShares Hedge Replication ETF. Altogether, there are 13 such ETFs traded on the American exchanges; they’ve returned an average of 4.9 percent year-to-date. Compared to the broader markets which have yielded 7.6 percent, it appears that hedge fund copycats can do better. Below are twenty stocks currently loved by some of the most successful money managers, forming our hypothetical hedge fund ETF.
These stocks have returned an average of 13.2 percent in 2012, and 67.6 percent since the summer of 2009. In the current year, the best performing stock of this bunch has been Sears Holdings (NASDAQ: SHLD), one of the largest retail chains in the United States. Sears has seen its shares nearly double in value YTD, mostly since the company spun off its Orchard Supply Hardware branch. Post split, Sears impressed with its first quarter earnings, beating analyst estimates, though same-store sales growth shrunk by a percentage point. Amid increasing competition from online retailers like Amazon and eBay, Sears has introduced a number of innovative strategies including: (1) the Shop Your Way rewards program, (2) a more forgiving layaway program, and (3) an online ordering program that offers same-day pickup called ‘mygofer.com’. The latter looks to have the most potential, as it is a relatively original service that can bridge the gap between Internet shoppers and its traditional brick and mortar business. Not to be outdone, eBay has explored a similar program, which can be read about here.
The second best performing stock of our hypothetical hedge fund ETF is Apple (NASDAQ: AAPL), which has returned 42.6 percent this year, and an astounding 314.1 percent over the past three years. As was discussed thoroughly in this article, Apple recently doubled its year-over-year first quarter earnings, placing it on target to eclipse an EPS of $40 for the first time in its storied history by the end of this year. A major driver of this growth has been the success of Apple products in China, as recent Q1 revenues in the country were $7.9 billion compared to $2.6 billion one year earlier. The tech giant has also announced that its next operating system will feature China-specific features, and that its iPad 3 has finally been approved for release by Chinese regulators. Intriguingly, shares of AAPL are trading below their historical P/E and P/CF metrics, which indicates that the stock’s value has yet to ‘catch up’ with Apple’s otherworldly growth. Going forward, Apple bulls should monitor the company’s ongoing negotiations with China Mobile, which holds 70 percent of the Chinese mobile phone market.
A personal favorite of Warren Buffett, Coca Cola (NYSE: KO) has seen its stock price nearly double since the recession. The soft drink company is the largest of its kind in the world, selling Coke and other bubbly products in over 200 countries. Over the past three years, KO has grown its revenues (13.4 percent) faster than the industry average (6.2 percent), while providing modest earnings growth (14.0 percent) to boot. In the first quarter of 2012, Coca Cola reported earnings of $0.89 a share, putting it on pace to finish the year with an EPS of $4.12. If consensus holds, this would be an 11.6 percent increase from 2011. Assuming that it remains near its current earnings valuation, shares of KO should rise from $75 a share to around $82 by year’s end. Supported by bearish commodity prices, the company has also been able to improve its margins this year, and sports operating (22 percent) and net (18.5 percent) margins above industry averages of 17.4 and 12.0 percent respectively. Though its current dividend yield (2.7 percent) is solid, analysts expect that this will increase over the coming year, as the company is currently sitting on a boatload of free cash flow over $6.5 billion high.
Another staple in our hypothetical hedge fund ETF is American International Group (NYSE: AIG), which has returned over 30 percent YTD. As the beneficiary of a $140 billion government bailout package in 2008, the multinational insurance provider had seen its stock price fall from a pre-crisis peak of $1,500 a share to below $10. As AIG continues to purchase back its stock from the Treasury and the Fed – the two lending organizations responsible for the bailout – investors have tended to become more bullish. This year alone, AIG has reduced its bailout debt by $8.5 billion, and currently owes $9.3 billion to the Fed and $35.8 billion to the Treasury. Going forward, the company will be a smarter organization, nixing its risky credit default swap operations for a greater focus in the property, casualty and life insurance arena. In this year’s first quarter, AIG reported an EPS of $1.65, trouncing analyst expectations of $1.12 a share. By the end of the year, the Street’s consensus is expecting earnings of $3.74 a share, which would mark a near 300 percent increase from 2011.
The other major performer on this list has been Delphi Automotive (NYSE: DLPH), one of the largest auto parts companies in the world. Historically, Delphi’s largest purchaser has been General Motors, which accounted for one-fifth of auto parts sales last year. Despite generally slow economic growth, the outlook for this industry is bullish, as vehicle production in the U.S. and abroad has grown steadily since the recession. Interestingly, the average American’s vehicle age is currently around 11 years old, which is a record. As a greater number of consumers trade in their beaters for newer cars, manufacturers like Delphi will likely benefit. Currently, shares of DLPH are trading below their historical P/E and P/CF averages, despite double-digit growth in annual earnings and cash flows in 2011. In the first quarter, Delphi beat the Street’s earnings estimates, reporting an EPS of $1.04, up 150 percent from Q1 of 2011.
While these particular stocks are loved by some of the world’s most successful hedge fund managers, this hypothetical ETF is not an end-all-be-all investment catalogue. Individual investors would be wise to use this list as a starting point for their own research. For those interested in more trading ideas in a rocky market environment, check out WealthLift INSIDER today.
Fool blogger Jake Mann does not own shares in any of the companies mentioned above. The Motley Fool owns shares of Apple and The Coca-Cola Company. Motley Fool newsletter services recommend American International Group, Apple, and The Coca-Cola Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.