The healthcare sector’s complexity has attracted more than a hundred hedge funds keen to find an edge, but at least three have shut down in the past year, Financial News reports.
Cantillon, the US firm set up by former Lazard manager William von Mueffling, last month decided to wind up its healthcare fund, saying the fund’s manager had been “unable to find enough shorts to properly implement the Cantillon investment philosophy”, which aims to balance long and short positions and targets a net return of at least 15 per cent.
US firm Caxton Associates six months ago shut down a specialist healthcare fund it had launched in 2004 and which had comprised assets of almost $600m. Last March, RX Capital Management wound up its healthcare fund, which it had launched in 2002 and which reached a peak at $650m. It had beaten its benchmark but not by enough to satisfy investors, more than half of whom had redeemed their capital, Financial News says.
Fund managers have been drawn in by the uncertain nature of the sector’s valuations combined with expectations that US medical spending will double this decade. But despite rosy prospects, the sector struggled last year amid concerns about pricing pressures, litigation and a weak pipeline of new drugs. Valuations hit historic lows last year, leaving fewer obvious opportunities for short-selling – hence the Cantillon shut-down.
The difficulty of establishing a reliable fair value for a healthcare stock – notably in pharmas, which heavily in research and development – looks like an opportunity to a confident hedge fund manager but entails considerable risk, the report said.
“Most of these stocks are valued by generalists and they get the prices wrong, because traditional valuation methods are not useful when it comes to companies with high R&D costs,” Kevin Pilarski, a partner at Kilkenny Capital Management, told Financial News.“We understand the probabilities and use a real options model to assess a range of likely values and decide whether to take a position. The trouble is the prices may stay wrong for a long time.”