The Smart Way to Follow the "Smart Money"

There seems to be a trend in financial media to publish long lists of stocks that were bought by successful hedge funds, but it doesn't do much good for individual investors. Here's the right way to follow the "smart money," without wasting your time on lists.

There seems to be a trend in financial media these days to publish lists of stocks that were bought by successful hedge funds. This accomplishes two things: It gives the appearance of adding value because investors always like to know what the smart money is doing. And more importantly for the publishers, the large list of stocks creates a lot of page views.

The latter doesn’t really do much for you. But it generates revenue for the websites that publish those lists. And the more investors click on them, the more revenue they generate. No matter that the investor is getting very little original thought or content he can actually use, other than perhaps some reassurance if he were fortunate enough to buy the stock before the hedge fund. If so, it’s nice to know that some smart guys with a lot of money behind them like the same stock.

These types of articles are useless for generating new ideas. The lists come from 13F filings. When a large hedge fund accumulates stock, it needs to file a 13F with the SEC. Funds are required to file the 13F within 45 days of the end of the quarter. Most wait the full 45 days because they don’t want everyone to know what they’re doing.

The quarter closes March 31, but funds don’t have to file until May 15. Then the lists start showing up. If you’re looking for a stock idea on May 21, what good does knowing that Bruce Berkowitz owned shares of Sears Holding Corp. (NASDAQ: SHLD) as of March 31? By the time you’re reading that, his position may have changed.

You also don’t know at what price he bought the stock or even when. Only that he owned it as of March 31.

There is some useful information, such as being able to tell which are new positions or large increases in the fund’s portfolio. But without dates and prices and especially with such a lag time, the data isn’t helpful if you want to follow the smart money into a stock.

But there is a way to do it, without wasting your time on these types of lists.

Start Tracking 13D Filings

Form 13D filings are required when a fund has to report that it owns 5% or more of a company and plans to (or reserves the right to) push management to make some changes. It can own 4.999% and not report a thing. But once it buys the share that pushes it across the 5% mark, it must file with the SEC within 10 days.

When a fund owns 5% or more of a company, it’s putting its money where its mouth is. You know that the company is invested for the long haul. A fund won’t go through the hassle of filing a 13D, where it will be labeled an activist investor, when it can simply file a 13F or 13G (if it has a 5% stake but expects to remain passive).

Some activist investors, like Carl Icahn, are very forceful in persuading management to make changes to the structure of the company, board of directors, or even sell the company.

But more importantly for investors, it’s much timelier than the other filings. Within two weeks, an investor knows what big fund managers are doing in a stock. If the activist sells stock or buys more -- he has to file an amended 13D, also within 10 days.

So by following the 13D, you’ll have a much more timely accounting of what the funds are doing in specific stocks.

For example, followers of Mario Gabelli might want to know that his Gamco Investors just bought large stakes in Internap Network Services Corp. (Nasdaq: INAP) and TradeStation Group Inc. (NASDAQ: TRAD). Gabelli purchased 3.1 million shares of Internap at an average of $7.37 and 2.2 million shares of TradeStation at $9.70.

Biogen Idec Inc. (NASDAQ: BIIB) shareholders might be interested in knowing that Carl Icahn sold 2.6 million of his 16 million shares at an average price of $99.60 between April 27 and May 20.

To find out which investors or stocks have 13Ds on file, visit the U.S. Securities and Exchange Commission website and search “SC 13D/A” in the box at the top of the page that allows you to limit your search results to a “Form Type.”

Following the smart money in a timely fashion is a smarter way to invest and won’t waste your time. Additionally, activist stocks tend to be good values with motivated investors pushing management to enhance the business and share price.

Marc Lichtenfeld is a Senior Analyst at InvestmentU.com. See related articles by Marc here.