21/04/2010 Author: Elana Margulies

The health of the future

With Obama's momentous healthcare proposals working their way through the US Senate, healthcare-focused hedge funds are looking ahead to the reconfigured space and identifying where future opportunities and challenges might lay

The initial outcry may have faded, but healthcare legislation is never far from the mind of the US public. It’s also an issue that is beginning to pique the interest of hedge funds, as they examine the opportunities and pitfalls of change.

As President Obama’s sweeping reforms await Senate approval, after the House of Representatives voted in favour of the Healthcare Bill last month, existing funds in the space are making changes to their portfolios, others are maintaining stock-picking as their first priority. A third group of managers is riding the back of uncertainty, by moving into healthcare for the first time.

Part of this new wave, Sunnymeath Asset Management, a New Jersey-based asset manager, has started to take a closer look at the sector, arguing that the Healthcare Bill's near-term impact on the equity markets will be positive.
James O’Mealia, the firm’s founder, said some of the areas the fund will examine include big pharmaceutical enterprises, biotechnology and product companies that supply the medical sector. “Pharma is going to continue to have its struggles,” he said. “The good news is there will be more people getting drugs because they will be getting coverage. The bad news is the companies will have pricing pressure and patent expiration.”

Historically, Sunnymeath has not been a prominent participant in the healthcare arena, but the proposed changes in US legislation have propelled it to compete with industry veterans. One of these, PBS Capital Management, a Texas-based healthcare fixed-income and equity hedge fund started by former Highland Capital employees, has only made one small change in light of Obama’s reform.

According to an HFMWeek source, PBS increased its exposure to liquid large-capitalisation stocks in a sector basket that included mainly pharmaceutical-related companies.

“Most of the legislation’s salient changes, including the all-important individual insurance mandate and insurance exchange creation, do not take place until 2014,” PBS Capital’s investor letter stated. “While we are keenly aware that the value of a security is the present value of future cashflows, we remain hesitant to capitalise cashflows driven by increased utilisation post-2014, thus have not deployed capital to the ‘obvious’ beneficiaries such as hospitals.”

Chordant Capital Partners, a Boston-based long/short global healthcare and life sciences fund which debuted at the beginning of the year, has modified some of its portfolio positions in the short-term due to the legislation. For example, it put more weight on the Amerigroup Corporation and athenahealth, along with a series of healthcare information technology companies.

Brian DeChristopher, the firm's founder, said when looking at the longer-term investment horizon of his portfolio, he remains concerned. Chordant has taken the view that certain healthcare technology, drugs and devices may fall behind the curve of innovation, if the sector relies on government funding of third-party research to establish the relevant efficiencies of each new development.

“I just don’t consider efficacy and safety, but also cost effectiveness,” he said. “A technology that creates efficiency in the healthcare system is something I will become more incrementally interested in.”

Unlike other healthcare-focused hedge funds, who have started to incorporate legislation into their investment philosophies, Locust Walk Capital Management, a long/short healthcare hedge fund expected to debut in June, remains stubbornly indifferent. It will continue to make its main focus bottom-up individual company investment picks that generate alpha for investors, with government policy in the backdrop.

“The pending healthcare reform has been an overhang on the sector for the last two years,” said Taran Bae,
managing partner. “Going forward with the healthcare reform, once finalised, will take the overhang away and allow people to model out the companies correctly and value the companies just on fundamentals. Coming into this year, we believe a lot of the healthcare reform impact was priced into stocks and the healthcare sector was undervalued and has played out.”

Howard Eisen, managing director and co-founder of FletcherBennett Group, an outsourced business development and consulting firm in New York, said he expects more healthcare-focused long/short hedge funds or multi-strategy offerings with healthcare as a focus to launch following the reform in Washington. However, as managers crowd into the space, not all can expect to be successful.

“There will be winners and losers across this value chain, across the different sub-sectors of healthcare,” he said. “You need a specialist set of experience and specialist network to capture the greatest opportunity in the space. It is very complicated and, particularly with the new legislation, I'm concerned that a generalist will miss the real opportunities and risks.”

While these uncertain opportunities and risks remain, a spate of new launches will fight to maintain an advantage. With numerous names debuting over the last few months, including PBS Capital, Chordant and, soon, Locust Walk and Burrage, the hedge fund industry is gearing up for more healthcare  investments.