The Perils of Following a Hedge Fund Manager

We are all looking for that edge when investing or trading, that one little nugget of information that will, over time, transform our stake into that pot of gold. Sometimes that edge is provided by following the big money flows and when a big money manager is taking a position either short or long we often want to ride his/her coattails, especially when they are so generous to let us know. The notion is that fund managers are much smarter than us and must have some sort of information that says they get it right all the time. It's just so easy, right? Some of the most successful hedge fund managers are winners for many reasons besides information and many have made themselves and their clients wealthy because of their actions. Most of us are not in a position to be in these funds, but if they are talking their book in the media then it should surely be OK to follow, right? Not necessarily. Some may have some great information and we in the public can choose to follow or not. Yet there are perils to following these managers and recent examples of failure show us why it is better to do our own due diligence. The latest hedge fund manager to take his place in the hot seat is Pershing Square Management's Bill Ackman. A known activist, Ackman has had some great success over the years presenting his case for/against some companies, but more recently has found himself in difficulty. Over the years, investors have followed this smart fund manager into some nice wins, so why shouldn't that happen each time Ackman is vocal? After all, an activist shareholder is looking out for the little guy, or so it seems. Many are well aware of his disdain for Herbalife (HLF) and the public battles with activist Carl Icahn and the company management. Ackman has frequently called the company a Ponzi scheme and has been short the stock for years. But that position seems to be at a substantial loss. Valeant Pharmaceuticals (VRX) has caught his affection and Ackman seems to have put his money where his mouth is. Further, he won't miss an opportunity to extoll the virtues of the company and how it is a great investment. Ackman has talked openly and often about the company and his long investment in the media and seemed to have enjoyed a great run, the stock peaking in August at more than $260, up well over 80% on the year. (I wrote a couple of bearish articles on this name for Real Money as it was collapsing.) Well, some recent negative news has hit the company and the stock has been in freefall, losing all of those gains and then some. As of the Nov. 6 close, Valeant was at $81 a share, having lost over 70% of its value in just two short months. Apparently, Ackman has doubled down on his bet, believing the troubles are going to disappear. Yet if you followed him into the stock you are sitting with a loss, probably a big one. What do you do now? Some activists are real value, like Carl Icahn, Nelson Peltz, Jim Chanos and Dan Loeb. They often do not trust management and provide a loud voice for the small investor. But we have to be careful. For every Netflix (NFLX) or Apple (AAPL) suggested by Icahn (both stellar), there is a Transocean (RIG) (awful). Bill Ackman has far more wins than losses over his career and has extracted more value for investors, but just blindly following him or any other investor could lead to a disastrous outcome like Valeant. The best answer is to do your own homework and research and then use these activists as a complementary anecdote if they happen to support your position or thesis.

The Perils of Following a Hedge Fund Manager

Do your own homework and research.

Columnist Conversation

Nasdaq Composite: Some Backing and Filling Is Here

Fabulous News on United Natural Foods (UNFI)

Michaels: Close to a Deal?

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.