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💰 Hedge Funds' Top Picks in Q3
Google, AI models, semiconductors, and global e-commerce
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Every quarter, funds managing over $100 million must share their portfolio moves as part of their 13F filings. These filings can be goldmines, providing unique insights into recent decisions made by some of the best money managers. So, let’s look at the Q3 update.
Today at a glance:
Hedge funds’ strategies.
Top buys and top holdings in Q3.
Implications for individual investors.
As usual, this seasonal article comes with some caveats. Blindly replicating the trades of the so-called ‘smart money’ is a recipe for disaster. Investing decisions are like shots from the 3-point range on a basketball court. Even Steph Curry—the best shooter in history—misses more than half of his attempts. In investing, there is no such thing as a sure bet.
Your patience and capacity to stay the course matters more than what you put in your portfolio. Your success hinges on your behavior. That’s why Peter Lynch says you should “know what you own and why you own it."
Conviction is a critical step in an investing framework because all companies go through a rough patch, and their stock inevitably collapses, at least temporarily.
As wonderfully put by Ian Cassel:
“You can borrow someone else’s stock ideas but you can’t borrow their conviction. True conviction can only be obtained by trusting your own research over that of others. Do the work so you know when to sell. Do the work so you can hold. Do the work so you can stand alone.”
Some limitations of 13F filings:
Offer a partial view, leaving out smaller funds.
Can be dated, given their submission 45 days post-quarter.
Exclude non-US equities, bonds, and commodities.
Omit short positions and cash reserves.
With all this said, let’s take a peek at what hedge funds were buying and holding in Q3 2023 and what we can glean from it.
1. Hedge funds’ strategies
Hedge funds are financial titans known for their sophisticated and flexible investment strategies aimed at achieving sky-high returns.
Here's a breakdown of the pillars shaping their strategies:
Market conditions: Hedge funds adjust their sails according to the economic winds. In bull markets, long positions may be favored, while bear markets might see an uptick in short selling or other defensive tactics.
Sector trends: Changes in consumer behavior or new legislation can drive hedge funds toward specific industries, influencing their buying patterns.
Company fundamentals: A company's earnings, cash flow, and management quality often dictate investment choices.
Macroeconomic factors: Global events, from interest rate changes to geopolitical shifts, play a significant role in hedge fund decision-making.
Quantitative models: Many funds employ complex, proprietary models, uncovering opportunities that traditional analyses might miss.
Risk management: Hedge funds don't just chase returns; they also strategically diversify to mitigate risks.
Investor sentiment: The market's mood can lead to undervalued opportunities or selling points in a euphoric market.
It doesn't always work out. The Global X Guru ETF (GURU), mirroring some top hedge funds, illustrates a sobering reality: it has trailed behind the S&P 500 (SPY) over the past decade.
This underperformance is compounded by the hefty '2 and 20' fee structure (2% of managed assets and 20% of profits), which can significantly erode returns. Intense market competition has put this model under scrutiny.
For individual investors, the takeaway is clear: while hedge funds' dynamic strategies and potential for high returns are enticing, understanding their methodologies and the associated costs is crucial.
2. Top buys and top holdings in Q3
In early 2020, before the COVID rally and subsequent market collapse, I selected a list of 20 top-performing hedge funds, according to TipRanks. Their methodology was based on the alpha generated compared to the S&P 500. While this list may evolve, it is a good starting point. So let's see what these funds, often featured in my social media feeds and podcast rotation, have been up to lately.
Remember, technology, communication, and consumer services represent most of the S&P 500, so it's not surprising to see these categories well represented in the list below.
Top 5 holdings at the end of September 2023:
The portfolios reveal some recurring themes:
☁️ Hyperscalers: AMZN, GOOG, and MSFT.
💳 Payments: MA, MELI, PYPL and V.
⚙️ Semiconductors: AMD and NVDA.
🌐 Global apps: META, UBER, and more.
Top 5 buys in Q3 (stocks they bought the most during the quarter):
This list reveals additional themes:
🔎 Alphabet top of mind: GOOG was a top 5 buy for seven funds.
🤖 AI and LLMs in focus: AMZN, META, and MSFT.
⚙️ Semiconductors: AMD, ASML, and NVDA.
🌏 Global commerce: PDD, SE, and MELI.
☁️ Software: ESTC and OKTA.
💳 Fintech: PYPL and SQ
Let's highlight a few notable companies:
Alphabet: The search giant was the most recurring name among these funds (showing up seven times this quarter, compared to only once in Q2). The company saw a rebound in advertising revenue in Q3 FY23, with Search and YouTube re-accelerating. However, Google Cloud slowed down meaningfully (particularly relative to Microsoft Azure), spooking investors. AI features have been slow to roll out, but that could change in 2024 with improvements to the Search Generative Experience (SGE) and the release of the AI system Gemini, created by DeepMind. The last witness at the ongoing antitrust trial revealed that Google pays Apple 36% of its Safari Search revenue to stay the iPhone's default search engine. For more on the latest quarter, check out our article below.
NVIDIA: One of the 2023 darlings remains a favorite among hedge funds. Your opinion on the stock may depend on your time horizon and risk profile. The stock is up nearly 240% this year and recently hit a new all-time high. We’ll cover the company’s earnings next week, so stay tuned for that! Here is the previous quarter if you need a refresher.
Meta: Facebook’s parent company generated a record $14 billion in free cash flow in Q3 after restructuring its business in the “year of efficiency.” We learned that half of the time users spend on Facebook and Instagram is now devoted to video content, illustrating the transformation of these platforms in recent years. Reels—Meta’s answer to the short-form video content a la TikTok—are driving engagement and improving monetization, which could be a tailwind in the coming quarters. Meta’s Llama 2 AI model powers new experiences for the company’s three billion daily active users, from content creation to AI assistants. We cover them in detail in the article linked below.
Pinduoduo: The company's unique social e-commerce model, which combines gamified features with group purchasing discounts, has resonated with consumers in China, particularly in lower-tier cities and rural areas. In Q2, Pinduoduo beat revenue expectations by 20%, leading to a significant rally in August. But the stock is still 44% off its 2021 peak. They report their Q3 performance at the end of the month.
As a reminder, I intentionally ignore the top sells of these funds as they can be misleading. So often, the top sells include some of these money managers' highest conviction holdings that they're merely trimming for risk management purposes.
What else was noteworthy among other funds outside of my scope?
Pershing Square (Bill Ackman) continued to increase its position in Alphabet, making it his biggest holding, including both tickers (GOOG and GOOGL).
Duquesne (Stanley Druckenmiller) took a new stake in Alphabet, its most significant investment in Q3. The new position makes up nearly 4% of the portfolio.
Buffett’s Berkshire Hathaway updated its stock portfolio holdings. While not a hedge fund, it’s a big one to track. Apple was 50% of the portfolio at the end of September. We compiled visuals of Berkshire’s top holdings here. 👇
3. Case studies
Let's look at some factors that led hedge funds to invest in particular stocks during Q3 to gain a more nuanced understanding.
Accelerating in Brazil and Mexico: Despite macro headwinds and regulatory risks, MercadoLibre, the dominant e-commerce platform in Latin America, continues to outperform.
Another record quarter: The company reported a 69% year-over-year revenue jump in constant currency to $3.8 billion, surpassing expectations by $250 million. Its income from operations more than doubled to $685 million.
Competitive edge: Despite competition from global giants like Amazon and Alibaba, MercadoLibre has expanded its market share, reinforcing its regional leadership. The platform saw a 36% increase in unique active users year-over-year, reaching 120 million across commerce and fintech. Network effects are kinking in.
User engagement growth: Gross Merchandise Volume (GMV) rose by 59%, and Total Payment Volume (TPV) grew 121% year-over-year, accelerating from the previous quarter and showing higher user engagement.
Resilience amid challenges: PayPal remains a favored pick despite recent challenges. Dorsey Asset Management nearly doubled its position last quarter. The company was modestly ahead of revenue and user engagement expectations in Q3. However, the user base decreased slightly to 428 million active accounts (a 3 million decline sequentially).
Leadership and strategy: New CEO Alex Chriss focuses on margin enhancement and exploring new categories like cryptocurrencies. His recent launch of a small business unit aligns with his successful history at Intuit.
“We must get PayPal Complete Payments to scale globally […] in the next couple of quarters. Once we accomplish this, we will have earned the right to expand additional offerings to small businesses.”
These case studies illustrate the significance of broadening our investment research and adopting second-level thinking. Hedge funds often double down on businesses showing strong momentum but also invest in companies that may seem momentarily out of favor.
4. Implications for individual investors
Hedge fund activities can be a gold mine of information, but they also come with additional caveats:
Diversify: Hedge funds don't put all their eggs in one basket. Spread your investments across various sectors and regions. You don’t have to bet the farm on a single company to generate wealth.
Look ahead: Many top funds invest with a future focus. They're not swayed by today's headlines but by a company's potential in the next few years. It's a good reminder not to let daily market buzz cloud our long-term vision.
Dig deeper: Sure, hedge funds have teams diving into every detail of a company. But that doesn't mean you don’t need to do your homework. Read about your investments, stay updated, and trust but verify.
Watch the fees: Costs eat into profits. It sounds simple, yet many overlook this. As Jack Bogle said, "In investing, you get what you don't pay for. Costs matter." Always know what you're being charged.
Use filings as a starting point: Hedge funds' 13F filings can offer great insights, but they're not real-time updates. These are snapshots, sometimes old ones. Still, they're great conversation starters for your research.
Watching hedge funds can be instructive, but your investment journey is personal. Make informed decisions that suit your goals and risk appetite.
Successful investing is not just about emulating the 'smart money'; it's about aligning your portfolio with your unique financial goals and understanding the risks involved.
While most of us won't have the vast resources of a hedge fund, we possess something just as potent – the ability to invest with patience and a long-term vision.
If you're looking for inspiration on the benefits of a long-term investment approach, check out our latest video on our YouTube Channel. We dive into the story of Robert Kirby and his Coffee Can Portfolio. His philosophy might challenge your entire investing approach.
Investing isn't about blindly following the herd. It's about carving your own path, armed with knowledge, patience, and a relentless pursuit of growth and learning.
That’s it for today!
Stay healthy and invest on!
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Disclosure: I am long AAPL, AMD, AMZN, APPN, ASML, GOOG, ESTC, HUBS, INTU, MELI, META, NU, NVDA, SE, SNOW, SQ, TSLA, TSM, UBER, V in the App Economy Portfolio. I share my ratings (BUY, SELL, or HOLD) with App Economy Portfolio members.
Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.