The investment world is full of old wives’ tales, outright falsehoods and ideas that make sense in theory but fail time and again when put into practice. 

One such falsehood is the belief that the big money players such as hedge funds and institutions never lose money. Nothing could be further from the truth. 

All one needs to do is look back to the 1998 Long-Term Capital Management (LTCM) disaster to prove this point. LTCM was a hedge fund managed by some of the market’s smartest guys, including Nobel Prize winners and top dogs from investment banks. Despite that pedigree, the fund lost more than $4 billion in 1998 and was forced to close its doors in 2000. Prior to that blowup, LTCM returned 40%-plus annual returns. It just goes to show that the big-money players can and do lose money.#-ad_banner-#

At the same time, some funds earn huge returns for their investors. It depends on the management, market environment and present strategy. When all three factors work together, the fund is in position to have a banner year. 

As an investor who follows the big money flows, I look for hedge funds that are earning outsize returns; I then research their holdings for possible investment — while always looking forward, aware that a strategy that worked yesterday could flop if conditions change. 

This approach has led me to a case of a top hedge fund whose glory days may be coming to an end.

Right now, Fortress Investment Group is the No. 1-performing fund group in 2013, which is estimated to have earned more than 40% this year alone. Unlike most hedge fund groups, the firm is publicly traded as Fortress Investment Group (NYSE: FIG). This enables investors to invest directly with the fund, as well as purchase the group’s top holdings. The shares have returned more than 80% over the past 52 weeks.

Fortress is heavily biased toward the financial sector, with more than 60% allocated to Nationstar Mortgage Holdings (NYSE: NSM), the second-largest U.S. mortgage originator and servicer. Benefiting from banks leaving the mortgage business, Nationstar reported incredible second-quarter results: Earnings per share (EPS) of $1.37 crushed estimates by nearly 40%, and revenue jumped 40% from the first quarter and close to 200% year over year.

But although I admire Fortress’ performance, I think its glory days are numbered. Despite the stellar performance, the technical patterns of both Fortress and Nationstar are looking tired and ready for a substantial pullback, and I don’t like Fortress’ large exposure to just one company. While the majority ownership has paid off handsomely so far, it’s too much concentrated risk for my taste. Let’s take a closer look.

Fortress has printed a double top on the daily chart in the $8.20 range. While the price remains substantially above the 200-day simple moving average in the $6.50 range and minor support exists at $7.20, it would not surprise me to see this stock drop to its 200-day simple moving average prior to breaking $8.50 on the upside. 

Nationstar Mortgage has been in an uptrend since the end of April with shares up more than 60%. However, shares have hit technical resistance at the $58 level. The 200-day simple moving average is currently $41, which is just over $15 from the current trading price. This chart also looks very tired to me, and despite my penchant for buying pullbacks, I don’t like this stock at these levels. I would also not be surprised to see shares around the 200-day simple moving average prior to $62.

Risks to Consider: Betting against proven hedge funds and companies can be risky. Remember, short positions go against the natural tendency of the market to push higher. Always be sure to use stop orders properly, particularly when shorting, and to diversify your holdings.

Action to Take –> It’s time to sell Fortress and Nationstar Mortgage. If you embrace risk, it is my contention that now is a good time to short both stocks. I would short Nationstar at the present level with stops at $62 and a nine-month target of $41. Fortress also appears to be a solid short with stops at $8.50 and a nine-month target in the $6 range.

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