Did Hedge Funds Make The Right Call On Kala Pharmaceuticals, Inc. (KALA)?

How do you pick the next stock to invest in? One way would be to spend days of research browsing through thousands of publicly traded companies. However, an easier way is to look at the stocks that smart money investors are collectively bullish on. Hedge funds and other institutional investors usually invest large amounts of capital and have to conduct due diligence while choosing their next pick. They don’t always get it right, but, on average, their stock picks historically generated strong returns after adjusting for known risk factors. With this in mind, let’s take a look at the recent hedge fund activity surrounding Kala Pharmaceuticals, Inc. (NASDAQ:KALA) and determine whether hedge funds had an edge regarding this stock.

Kala Pharmaceuticals, Inc. (NASDAQ:KALA) shareholders have witnessed an increase in support from the world’s most elite money managers lately. KALA was in 18 hedge funds’ portfolios at the end of the first quarter of 2020. There were 10 hedge funds in our database with KALA holdings at the end of the previous quarter. Our calculations also showed that KALA isn’t among the 30 most popular stocks among hedge funds (click for Q1 rankings and see the video for a quick look at the top 5 stocks).

Video: Watch our video about the top 5 most popular hedge fund stocks.

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 58 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.

Peter Kolchinsky of RA Capital Management

At Insider Monkey we scour multiple sources to uncover the next great investment idea. We go through lists like the 10 most profitable companies in America to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. If you want to find out the best healthcare stock to buy right now, you can watch our latest hedge fund manager interview here. With all of this in mind we’re going to go over the fresh hedge fund action regarding Kala Pharmaceuticals, Inc. (NASDAQ:KALA).

How have hedgies been trading Kala Pharmaceuticals, Inc. (NASDAQ:KALA)?

Heading into the second quarter of 2020, a total of 18 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of 80% from one quarter earlier. On the other hand, there were a total of 12 hedge funds with a bullish position in KALA a year ago. So, let’s examine which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

Among these funds, RA Capital Management held the most valuable stake in Kala Pharmaceuticals, Inc. (NASDAQ:KALA), which was worth $95.6 million at the end of the third quarter. On the second spot was OrbiMed Advisors which amassed $47.5 million worth of shares. Millennium Management, Opaleye Management, and Vivo Capital were also very fond of the stock, becoming one of the largest hedge fund holders of the company. In terms of the portfolio weights assigned to each position RA Capital Management allocated the biggest weight to Kala Pharmaceuticals, Inc. (NASDAQ:KALA), around 3.02% of its 13F portfolio. Opaleye Management is also relatively very bullish on the stock, designating 1.92 percent of its 13F equity portfolio to KALA.

As aggregate interest increased, some big names were leading the bulls’ herd. Opaleye Management, managed by James A. Silverman, assembled the most valuable position in Kala Pharmaceuticals, Inc. (NASDAQ:KALA). Opaleye Management had $7.2 million invested in the company at the end of the quarter. Richard Driehaus’s Driehaus Capital also initiated a $4.4 million position during the quarter. The following funds were also among the new KALA investors: Greg Martinez’s Parkman Healthcare Partners, Renaissance Technologies, and Srini Akkaraju and Michael Dybbs’s Samsara BioCapital.

Let’s now review hedge fund activity in other stocks similar to Kala Pharmaceuticals, Inc. (NASDAQ:KALA). These stocks are Bain Capital Specialty Finance, Inc. (NYSE:BCSF), Hawaiian Holdings, Inc. (NASDAQ:HA), Univest Financial Corporation (NASDAQ:UVSP), and iHeartMedia, Inc. (NASDAQ:IHRT). This group of stocks’ market values match KALA’s market value.

View table here if you experience formatting issues.

As you can see these stocks had an average of 16.5 hedge funds with bullish positions and the average amount invested in these stocks was $55 million. That figure was $183 million in KALA’s case. iHeartMedia, Inc. (NASDAQ:IHRT) is the most popular stock in this table. On the other hand Bain Capital Specialty Finance, Inc. (NYSE:BCSF) is the least popular one with only 8 bullish hedge fund positions. Kala Pharmaceuticals, Inc. (NASDAQ:KALA) is not the most popular stock in this group but hedge fund interest is still above average. This is a slightly positive signal but we’d rather spend our time researching stocks that hedge funds are piling on. Our calculations showed that top 10 most popular stocks among hedge funds returned 41.4% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks gained 18.6% in 2020 through July 27th but beat the market by 17.1 percentage points. Unfortunately KALA wasn’t nearly as popular as these 10 stocks and hedge funds that were betting on KALA were disappointed as the stock returned 5.1% during the same time period and underperformed the market. If you are interested in investing in large cap stocks with huge upside potential, you should check out the top 10 most popular stocks among hedge funds as many of these stocks already outperformed the market so far this year.

Disclosure: None. This article was originally published at Insider Monkey.