Thinking About Investing in a Hedge Fund?

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The hedge fund industry, through negative media attention and the occasional jaw-dropping paydays we hear about, has cultivated an air of mystique for the average investor. Many assume these privileged money managers simply know things others don't or have superhuman analytical skills, a la Warren Buffett.

There is no question that some of these professionals have incredible stock-picking abilities or are fierce traders. But if you look at the top stocks attracting hedge fund capital, it's startlingly boring.

The winner is...
If you started reading this article thinking that Apple (NAS: AAPL) would be the No. 1 holding among the biggest hedge funds...you'd be right.


Out of the 50 biggest funds, 12 of them have Apple as their largest holding. Well, we already know that Apple is a good company that is a relatively safe hold for the next few years. In fact, I would say that if you were to ask a random person on the street which single company he or she would choose to invest in, the vast majority would say Apple. So, the Harvard MBAs, the two and 20 fee structure that eats your profits, the potential Ponzi schemes -- they all get you into the same stock you probably already have in your portfolio.

I don't hate hedge fund managers. I respect many of them for their innovative techniques and amazing success. Take David Einhorn, for example. The manager of Greenlight Capital is undoubtedly one of the best money managers of our time. Whether long or short, he makes compelling arguments that are often spot on. One of his most recent short attacks was on Green Mountain Coffee Roasters (NAS: GMCR) . Einhorn, among others, pointed out the company's total lack of transparency and its senseless run-up in stock price throughout 2011. His fund was short the stock and has since made a pretty penny.

But even Einhorn, the sleuth, seems to believe there is no better place for his money than Apple. In Greenlight's latest 13-F, Apple is by far the largest holding.

It is necessary to keep in mind that there is a difficulty with assets under management. Once a fund grows well into the billions, it becomes impossible to invest a meaningful amount in small caps, where I believe the most talented fund managers find their most lucrative quarry. You just can't buy enough of a company to move the needle on the fund's returns without having a material impact on its share price.

They're famous investors -- but why?
John Paulson is one of the most well-known money managers around. His bets against the U.S. housing market right before the collapse earned him billions personally. The man is surely talented, and he was able to see the iceberg right before we hit, but his fund's biggest holding is the SPDR Gold Trust. Of all the options in the equities markets, Paulson says, "No, I want gold." I'll never forget Buffett's comment on gold in a recent Berkshire letter:

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.

Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 ExxonMobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

As usual, Buffett makes perfect sense to me on this matter. So how could the talented and able John Paulson consider gold to be the absolute best place for his investors' money? I don't get it.

It gets better
This is my favorite one. Bridgewater Associates has $122 billion under management and is listed as a value fund. How did the fund reach such a staggering size? With unbelievable analysis and genius investing techniques -- right?

Bridgewater's top holding: SPDR S&P 500 ETF (NYS: SPY) .

I wish I were kidding. For a mere 2% of whatever you invest and an additional 20% of your investing profits, you can access a group of money managers who, by some astonishing talent, can put your cash into the S&P 500. Sarcastic analysts want to know: How did they even find such a remarkable ETF?

Keep on keepin' on
If you're tempted to hand over your investing to professionals, do so with caution and know that these "professionals" are probably doing the same thing you are -- if not worse. The air of superiority cultivated by the financial elite is similar to the air you smell when you walk over a New York City subway vent.

Keep on doing your own homework, and let us help. Take a look at the premium reports for both Apple and Green Mountain Coffee Roasters. These reports will help you determine whether these stocks are good for your portfolio in the coming years.

The article Thinking About Investing in a Hedge Fund? originally appeared on Fool.com.

Fool contributor Michael Lewis owns none of the stocks mentioned above. You can follow him on Twitter@MikeyLewy.The Motley Fool owns shares of Green Mountain Coffee Roasters and Apple.Motley Fool newsletter serviceshave recommended buying shares of Green Mountain and Apple, as well as creating a lurking gator position in Green Mountain, a bull call spread position in Apple, and a bear put spread position in SPDR S&P 500 ETF. The Motley Fool has adisclosure policy.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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