10 Small Hedge Funds with Exceptional Returns

As we’ve been doing extensive research comparing active investment managers, small hedge funds tend to outperform large hedge funds. Hedge Fund Managers like Buffett and Klarman are famous, but the top hedge funds tend to be young and small.

Although The most famous hedge fund managers have their reputations as wealth creators are based on returns which occurred when their funds were new and small. With some exceptions, the recent performance of the bigger hedge fund mangers has been mediocre.

This week, let’s take a look at the top 10 hedge funds who stock picks have consistently outperformed large and established funds, yet their funds holdings are less than $1 Bn.

Table 1: 13F filings, Sec.gov

Top of this list will be Pat Dorsey, who runs Chicago-based Dorsey Asset Management founded in 2013 and had $526 Million assets under management as of March 31, 2019. Dorsey uses “moats” as a framework to analyze a company’s competitive advantage.

The Five Rules for Successful Stock Investing and The Little Book that Builds Wealth. In a previous article, I discussed that Dorsey has identified four types of moats — competitive business advantages — that he uses to inform his stock picking.

• Intangible Assets 

• Switching Costs 

• Network Effects 

• Cost Advantages 
  
  

Yet Dorsey’s hedge fund has AUM of only $688M, the great majority of which is reported in 13F filings. (Suggesting the hedge fund does minimal hedging.) Dorsey runs a very concentrated portfolio, consisting of just 11 stocks at Q3’s end.

Source: Dorsey Asset Management LLC, 13F Filings 2020 holdings in Percentage %

Another small fund with a concentrated portfolio and very impressive performance is Valley Forge Capital Management. Valley Forge Capital Management has generated great returns since 2016, but has only $920Mn. in 13F Securities.

Like most hedge funds, the investment objective of the Fund is to outperform the S&P 500 index over multi-year timeframe through the selection of companies that the Firm believes are trading at a large discount. In the case of long equity positions or premiums, in the case of short equity positions to their intrinsic value.

Let’s take a look at Valley Forge first filed a 13F, the fund has achieved this goal — and then some. Valley Forge’s three year annual performance was 25.13% through Q3. Since 2017, an equal-weight portfolio of the fund’s top 10 long holdings has averaged a 29.46% return. The fund’s largest holding was S&P Global inc. (SPGI), representing 24.81% of the fund’s 13F portfolio as of the quarter’s end.

Valley Forge Capital Management is based out of Wayne. Valley Forge Capital Management is a hedge fund with 1 clients and discretionary assets under management (AUM) of $543,453,598 (Form ADV from 2020-05-29). Their last reported 13F filing for Q3 2020 included $921,599,000 in managed 13F securities and a top 10 holdings concentration of 100.0%.

Source: Valley Forge Capital Management LLC, 13F Filings 2020 holdings in Percentage %

When it comes to Risk Management, a key tenet of hedge funds investment process is assessing the margin of safety in prospective investments, and therefore risk management starts at the position level. Smaller and more nimble hedge fund managers views risk as potential for permanent impairment of capital and not the volatility of a security.

Hedge Fund managers seeks to manage risk through fundamental analysis and disciplined portfolio construction, and in general will re-allocate capital to what it believes are the best risk/reward scenarios. [The fund] believes its probability weighted approach to stock selection also adequately accounts for individual stock risks and therefore position weightings reflect this implied risk. 

Bar Chart 2: The ten most popular Large hedge funds/managers followed by investors. *based on funds that filed a 1st qtr. 2018 13F Annualized Returns in Percentage %

Here’s a secret that many investors of the hedge fund giants may not realize: Like classic heavy weight stars of Large Hedge Funds in Table 2: who had their biggest hits years ago, the famous hedge fund managers’ reputations were built when their multi-billion-dollar hedge funds were younger, smaller and more profitable.