Hedge Funds Were Selling American Equity Investment Life Holding (AEL) Before The Coronavirus

Reymerlyn Martin

Sat, Mar 28, 2020, 6:28 PM 7 min read

We hate to say this but, we told you so. On February 27th we published an article with the title Recession is Imminent: We Need A Travel Ban NOW and predicted a US recession when the S&P 500 Index was trading at the 3150 level. We also told you to short the market and buy long-term Treasury bonds. Our article also called for a total international travel ban. While we were warning you, President Trump minimized the threat and failed to act promptly. As a result of his inaction, we will now experience a deeper recession (see why hell is coming).

In these volatile markets we scrutinize hedge fund filings to get a reading on which direction each stock might be going. Keeping this in mind, let's take a look at whether American Equity Investment Life Holding (NYSE:AEL) is a good investment right now. We like to check what the smart money thinks first before doing extensive research on a given stock. Although there have been several high profile failed hedge fund picks, the consensus picks among hedge fund investors have historically outperformed the market after adjusting for known risk attributes. It's not surprising given that hedge funds have access to better information and more resources to predict the winners in the stock market.

Is American Equity Investment Life Holding (NYSE:AEL) undervalued? Prominent investors are getting less bullish. The number of long hedge fund bets went down by 2 lately. Our calculations also showed that AEL isn't among the 30 most popular stocks among hedge funds (click for Q4 rankings and see the video at the end of this article for Q3 rankings).

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 41 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.

[caption id="attachment_365194" align="aligncenter" width="400"]

David E. Shaw of D.E. Shaw[/caption]

We leave no stone unturned when looking for the next great investment idea. For example we recently identified a stock that trades 25% below the net cash on its balance sheet. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences, and go through short-term trade recommendations like this one. We even check out the recommendations of services with hard to believe track records. Our best call in 2020 was shorting the market when S&P 500 was trading at 3150 after realizing the coronavirus pandemic's significance before most investors. Keeping this in mind let's view the latest hedge fund action regarding American Equity Investment Life Holding (NYSE:AEL).

How have hedgies been trading American Equity Investment Life Holding (NYSE:AEL)?

At Q4's end, a total of 17 of the hedge funds tracked by Insider Monkey held long positions in this stock, a change of -11% from one quarter earlier. By comparison, 17 hedge funds held shares or bullish call options in AEL a year ago. So, let's check out which hedge funds were among the top holders of the stock and which hedge funds were making big moves.

The largest stake in American Equity Investment Life Holding (NYSE:AEL) was held by Pzena Investment Management, which reported holding $48.1 million worth of stock at the end of September. It was followed by GLG Partners with a $9.2 million position. Other investors bullish on the company included D E Shaw, Citadel Investment Group, and Voleon Capital. In terms of the portfolio weights assigned to each position Quantinno Capital allocated the biggest weight to American Equity Investment Life Holding (NYSE:AEL), around 0.48% of its 13F portfolio. Pzena Investment Management is also relatively very bullish on the stock, setting aside 0.22 percent of its 13F equity portfolio to AEL.

Judging by the fact that American Equity Investment Life Holding (NYSE:AEL) has faced declining sentiment from the aggregate hedge fund industry, it's safe to say that there were a few money managers that decided to sell off their entire stakes heading into Q4. Interestingly, Renee Yao's Neo Ivy Capital cut the largest stake of all the hedgies watched by Insider Monkey, worth close to $0.9 million in stock. Bruce Kovner's fund, Caxton Associates LP, also cut its stock, about $0.7 million worth. These moves are important to note, as total hedge fund interest dropped by 2 funds heading into Q4.

Let's now take a look at hedge fund activity in other stocks - not necessarily in the same industry as American Equity Investment Life Holding (NYSE:AEL) but similarly valued. These stocks are Extended Stay America Inc (NASDAQ:STAY), Urban Outfitters, Inc. (NASDAQ:URBN), The Simply Good Foods Company (NASDAQ:SMPL), and Proto Labs Inc (NYSE:PRLB). All of these stocks' market caps match AEL's market cap.

[table] Ticker, No of HFs with positions, Total Value of HF Positions (x1000), Change in HF Position STAY,35,496027,8 URBN,34,170783,0 SMPL,34,242325,12 PRLB,10,33102,0 Average,28.25,235559,5 [/table]

View table here if you experience formatting issues.

As you can see these stocks had an average of 28.25 hedge funds with bullish positions and the average amount invested in these stocks was $236 million. That figure was $89 million in AEL's case. Extended Stay America Inc (NASDAQ:STAY) is the most popular stock in this table. On the other hand Proto Labs Inc (NYSE:PRLB) is the least popular one with only 10 bullish hedge fund positions. American Equity Investment Life Holding (NYSE:AEL) is not the least popular stock in this group but hedge fund interest is still below average. This is a slightly negative signal and we'd rather spend our time researching stocks that hedge funds are piling on. Our calculations showed that top 20 most popular stocks among hedge funds returned 41.3% in 2019 and outperformed the S&P 500 ETF (SPY) by 10.1 percentage points. These stocks lost 17.4% in 2020 through March 25th but beat the market by 5.5 percentage points. Unfortunately AEL wasn't nearly as popular as these 20 stocks (hedge fund sentiment was quite bearish); AEL investors were disappointed as the stock returned -39.7% 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 20 most popular stocks among hedge funds as most of these stocks already outperformed the market in Q1.