Wisdom of the Crowd: A New Stock-Picking Strategy Rooted in Old Insights

Takeaways

• During the mature phase of an equity bull market, it is important to continue to participate on the upside while still holding onto some protection on the eventual downside. After all, everyone needs some equity exposure.
• One approach to consider at such a juncture is to focus the long position on those names in which hedge fund managers on the whole have the most conviction, based on public filings.

• The Novus Wisdom of the Crowd Index is a tool that institutional investors now have available to play a smart allocation to equity along the principle described above. The index is constructed solely based on public filing information.

None of us is as smart as all of us. – Ken Blanchard

In the first half of 2021, the S&P 500 returned 15.25% on a total-return basis. And while some of that is attributable to the “V-shaped recovery” following the Covid-19 pandemic, the crisis itself merely paused what had already been a decade-long surge in equity prices.

Still, every other bull market came to an end, and this one will too. So what if there were a way to participate on the upside while still holding onto some protection on the eventual downside?

The Novus Wisdom of the Crowd Index has, since its inception, consistently outperformed the broader market. In July 2021, Novus entered into an alliance with Switzerland-based investment firm Silex to leverage the research behind the index into a product that offers both that upside exposure and that downside defense. The product is named, aptly, $WISE.

The index focuses on names held by fundamental equity managers as per data contained in public filings.  

Long & Short  

Wisdom of the Crowd’s methodology sources stocks for its long and short sides from the hedge fund community, basing decisions on Securities and Exchange Commission filings (public filings). Form 13F discloses the number of shares and market value of every US-based long stock over which an asset manager exercises investment discretion.

The long side consists of the 20 highest-conviction holdings among fundamental equity managers.

If stocks moved only one direction – up – a portfolio such as that presented in the table above might be adequate. To guard against the downside, however, the Wisdom of the Crowd Index shorts 20 stocks based on Novus’s consensus filter, comprised of stocks which are widely held but lack the size within the managers’ portfolios that signifies conviction.

The current short exposure is concentrated in the Healthcare sector, as most funds are long healthcare names even while showing little conviction as to which individual stocks will benefit most from the effects of and response to the Covid-19 pandemic. Inspecting healthcare securities within the sector would reveal small position sizes in several names.

Portfolio construction, at 125% weight for the long exposure and 50% weight for the short exposure, has supported a positive 15.51% return as of the end of June, very close to the S&P 500’s return over the same period. In January 2021, when the hedge fund community struggled with GameStop and other meme stocks, the Novus Wisdom of the Crowd Index was unaffected.  

You can explore the Novus 4C Indices for yourself—including Conviction and Consensus—in this free interactive dashboard. Explore risk & return stats, sector exposure, and 5 sample positions per index, updated quarterly. (Clients of Novus have access to the full list of constituent securities.)

Wise Results  

How can the Novus Wisdom of the Crowd Index provide such solid results? Let’s look at just one of the many drivers of performance.  

Year-to-date, the short exposure is exclusively in mega-cap names, that is, those with market caps exceeding $50 billion. This is because the consensus filter lists the most liquid securities, thus isolating the portfolio from those which fell victim to short squeezes.

Conclusion  

There are a number of other “best ideas strategies” that attempt to access the collective wisdom of the hedge fund community, and some even start with the same publicly available SEC dataset. Why not just try it yourself? While anyone can hypothetically access the underlying 13Fs filings, the greater task is cleansing, harmonizing, and (most importantly) knowing which funds to pay attention to—even before you start thinking about setting rules for a portfolio. Novus’ “Best Ideas” podcast delves into many of the challenges to assembling such a model. Identifying managers worth paying attention to, along with the experience of Novus to mine, parse, and structure a portfolio from this public dataset, combine to make the secret sauce.

For inquiries related on how to seek economic exposure to the research index discussed here, please contact Silex at wise@silex-partners.com.  

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This article is provided for information purposes only, does not constitute investment advice, or an offer to buy or sell securities, and should not be deemed to be a recommendation to make any investment. Novus is not an investment adviser, broker dealer, or financial institution and does not offer or provide advice regarding analysis of securities or effecting transactions in securities.