Did Hedge Funds Make The Right Call On Kratos Defense & Security Solutions, Inc (KTOS)?

We know that hedge funds generate strong, risk-adjusted returns over the long run, which is why imitating the picks that they are collectively bullish on can be a profitable strategy for retail investors. With billions of dollars in assets, professional investors have to conduct complex analyses, spend many resources and use tools that are not always available for the general crowd. This doesn’t mean that they don’t have occasional colossal losses; they do. However, it is still a good idea to keep an eye on hedge fund activity. With this in mind, let’s examine the smart money sentiment towards Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS) and determine whether hedge funds skillfully traded this stock.

Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS) investors should be aware of an increase in support from the world’s most elite money managers in recent months. Our calculations also showed that KTOS 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.

Ken Griffin of Citadel Investment Group

At Insider Monkey we scour multiple sources to uncover the next great investment idea. With Federal Reserve creating trillions of dollars out of thin air, we believe gold prices will keep increasing. So, we are checking out gold stocks like this small gold mining company. 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 let’s analyze the recent hedge fund action regarding Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS).

How are hedge funds trading Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS)?

At the end of the first quarter, a total of 18 of the hedge funds tracked by Insider Monkey were long this stock, a change of 13% from the fourth quarter of 2019. On the other hand, there were a total of 17 hedge funds with a bullish position in KTOS a year ago. So, let’s find out which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

More specifically, Balyasny Asset Management was the largest shareholder of Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS), with a stake worth $15.4 million reported as of the end of September. Trailing Balyasny Asset Management was D E Shaw, which amassed a stake valued at $6.2 million. Millennium Management, Citadel Investment Group, and Osterweis Capital Management 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 Diametric Capital allocated the biggest weight to Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS), around 1.63% of its 13F portfolio. Weld Capital Management is also relatively very bullish on the stock, setting aside 0.31 percent of its 13F equity portfolio to KTOS.

Now, some big names were breaking ground themselves. Balyasny Asset Management, managed by Dmitry Balyasny, initiated the largest position in Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS). Balyasny Asset Management had $15.4 million invested in the company at the end of the quarter. Nick Thakore’s Diametric Capital also made a $1.3 million investment in the stock during the quarter. The other funds with new positions in the stock are Minhua Zhang’s Weld Capital Management, Greg Eisner’s Engineers Gate Manager, and Qing Li’s Sciencast Management.

Let’s go over hedge fund activity in other stocks – not necessarily in the same industry as Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS) but similarly valued. We will take a look at Ingevity Corporation (NYSE:NGVT), Insperity Inc (NYSE:NSP), Sinclair Broadcast Group, Inc. (NASDAQ:SBGI), and Navient Corp (NASDAQ:NAVI). This group of stocks’ market valuations are similar to KTOS’s market valuation.

View table here if you experience formatting issues.

As you can see these stocks had an average of 29 hedge funds with bullish positions and the average amount invested in these stocks was $163 million. That figure was $45 million in KTOS’s case. Navient Corp (NASDAQ:NAVI) is the most popular stock in this table. On the other hand Sinclair Broadcast Group, Inc. (NASDAQ:SBGI) is the least popular one with only 25 bullish hedge fund positions. Compared to these stocks Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS) is even less popular than SBGI. Hedge funds clearly dropped the ball on KTOS as the stock delivered strong returns, though hedge funds’ consensus picks still generated respectable returns. 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 and still beat the market by 17.1 percentage points. A small number of hedge funds were also right about betting on KTOS as the stock returned 33.3% since the end of March and outperformed the market by an even larger margin.

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