Were Hedge Funds Right About Betting On Ares Capital Corporation (ARCC)?

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 Ares Capital Corporation (NASDAQ:ARCC) and determine whether hedge funds had an edge regarding this stock.

Is Ares Capital Corporation (NASDAQ:ARCC) an exceptional investment now? Investors who are in the know were in an optimistic mood. The number of bullish hedge fund positions increased by 4 recently. Our calculations also showed that ARCC 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). ARCC was in 26 hedge funds’ portfolios at the end of March. There were 22 hedge funds in our database with ARCC holdings at the end of the previous quarter.

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

So, why do we pay attention to hedge fund sentiment before making any investment decisions? 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 more than 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. Even if you aren’t comfortable with shorting stocks, you should at least avoid initiating long positions in stocks that are in our short portfolio.

Peter Rathjens of Arrowstreet Capital

At Insider Monkey we scour multiple sources to uncover the next great investment idea. There is a lot of volatility in the markets and this presents amazing investment opportunities from time to time. For example, this trader claims to deliver juiced up returns with one trade a week, so we are checking out his highest conviction idea. A second trader claims to score lucrative profits by utilizing a “weekend trading strategy”, so we look into his strategy’s picks. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. Hedge fund sentiment towards Tesla reached its all time high at the end of 2019 and Tesla shares more than tripled this year. We are trying to identify other EV revolution winners, so we are checking out this tiny lithium stock. With all of this in mind we’re going to go over the fresh hedge fund action regarding Ares Capital Corporation (NASDAQ:ARCC).

How are hedge funds trading Ares Capital Corporation (NASDAQ:ARCC)?

At the end of the first quarter, a total of 26 of the hedge funds tracked by Insider Monkey were long this stock, a change of 18% from the fourth quarter of 2019. By comparison, 22 hedge funds held shares or bullish call options in ARCC a year ago. With hedge funds’ sentiment swirling, there exists an “upper tier” of key hedge fund managers who were adding to their stakes substantially (or already accumulated large positions).

Among these funds, D E Shaw held the most valuable stake in Ares Capital Corporation (NASDAQ:ARCC), which was worth $34 million at the end of the third quarter. On the second spot was Arrowstreet Capital which amassed $24.7 million worth of shares. Two Sigma Advisors, Citadel Investment Group, and Callodine 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 Tegean Capital Management allocated the biggest weight to Ares Capital Corporation (NASDAQ:ARCC), around 12.18% of its 13F portfolio. Callodine Capital Management is also relatively very bullish on the stock, setting aside 2.85 percent of its 13F equity portfolio to ARCC.

As industrywide interest jumped, key hedge funds have jumped into Ares Capital Corporation (NASDAQ:ARCC) headfirst. Callodine Capital Management, managed by James Morrow, established the biggest position in Ares Capital Corporation (NASDAQ:ARCC). Callodine Capital Management had $7 million invested in the company at the end of the quarter. Randall Smith’s Alden Global Capital also made a $6.2 million investment in the stock during the quarter. The other funds with new positions in the stock are Thomas G. Maheras’s Tegean Capital Management, Chen Tianqiao’s Shanda Asset Management, and Donald Sussman’s Paloma Partners.

Let’s check out hedge fund activity in other stocks similar to Ares Capital Corporation (NASDAQ:ARCC). These stocks are Sonoco Products Company (NYSE:SON), Credit Acceptance Corp. (NASDAQ:CACC), Tallgrass Energy, LP (NYSE:TGE), and BWX Technologies Inc (NYSE:BWXT). All of these stocks’ market caps are similar to ARCC’s market cap.

View table here if you experience formatting issues.

As you can see these stocks had an average of 26.75 hedge funds with bullish positions and the average amount invested in these stocks was $376 million. That figure was $129 million in ARCC’s case. Tallgrass Energy, LP (NYSE:TGE) is the most popular stock in this table. On the other hand Credit Acceptance Corp. (NASDAQ:CACC) is the least popular one with only 22 bullish hedge fund positions. Ares Capital Corporation (NASDAQ:ARCC) is not the least popular stock in this group but hedge fund interest is still below average. 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 12.3% in 2020 through June 30th and still beat the market by 15.5 percentage points. A small number of hedge funds were also right about betting on ARCC as the stock returned 37.8% during the second quarter and outperformed the market by an even larger margin.

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