Manager Monday: HealthCor Management

Background on Healthcare

The Healthcare sector is very attractive to hedge fund managers, even after recent volatility. It’s exactly the sort of area where specific domain expertise makes a huge difference, and investors are open to hiring a professional to help them navigate rough waters. Dispersion between the high and low performing companies is extremely wide, (this makes it great for stock pickers) and the intra-correlations are generally lower than within other sectors. This makes the area fertile picking grounds for shorts.

More dispersion means more opportunity for a long/short strategy to deliver outsized alpha. Nothing is more irritating to Hedge Fund managers than operating in a low dispersion environment and having their shorts run up on them for no good reason. These were the findings published in our June 2015 research, When Does Specializing in a Sector Make Sense? In the paper, we covered portfolios of over 1,000 managers and noted that high dispersion sectors pay stock pickers to make similar kinds of trades. Moreover, our research showed that over a 25 year period from 1990 -2015, the healthcare sector showed some of the highest values of dispersion and alpha.

In addition to that work, we wrote about the healthcare sector specifically, and mentioned how the Hedge Fund industry was chasing both beta and alpha in that market segment. The manager list in that article contains the top stock pickers in healthcare. We wrote follow-up pieces on some of the managers listed, including RA Capital, Deerfield, and Palo Alto. For this post, we’ll analyze the investment acumen of another HC specialist on that list: HealthCor Management.

Data

As usual for our Manager Mondays, everything mentioned in this post is sourced exclusively from public data, including the manager’s profile, simulated performance and all other analysis and commentary. The data used here omits the short side, non-equity securities, many non-US securities and all non-public information such as actual fund performance. To simulate performance and determine portfolio attributes such as liquidity, we combine public holdings data with market and pricing data and make simple assumptions. The period analyzed is January 1st 2006 through October 31st 2015.

HealthCor Introduction

In the exclusive world of Hedge Funds, pedigree plays a critical role, and the founders of HealthCor do not lack for pedigree. Arthur Cohen, a UVA graduate, was responsible for healthcare at Julian Robertson’s Tiger Management for five years. Joseph Healey, a BU graduate, was responsible for healthcare at Mark Kingdon’s Kingdon Capital. In 2000, Art and Joe joined SAC as a team managing the healthcare portfolio until 2005, when they jointly launched HealthCor.

Investing in the healthcare sector, the manager seeks to be meaningfully involved with its portfolio companies and at times has taken activist stakes (AllScripts is one example).

Looking at the performance of their public long equities, we can see that they added 132 percentage points above the S&P 1500 Healthcare index (310% vs. 178%) and 205 percentage points over the S&P 500. Let’s dive in to see how they generated this outperformance.

While the manager focuses on healthcare today, they did have occasional investments outside the healthcare industry, but the predominant portion of the book (93% on avg.) has been allocated to their main sector since first filing. As we can see from the following table, healthcare is responsible for the majority of their lifetime P&L, and shows high batting averages and win/loss ratios. This means that they are more often right than wrong (higher number of winning vs. losing trades) and make more when they’re right than they lose when they’re wrong (average contribution is higher for winners than losers).

What’s driving those numbers is the simple fact that the stocks HealthCor chooses have extremely high return, (in HC in particular) even when compared to a benchmark. Take a look at the following two charts, one for HealthCor and the next for the S&P 1500. Both charts display the average cumulative return for each stock in every sector over the same date period (Jan 2006 – Oct 2015).

HealthCor Average Security Performance by Sector (2006 – 2015):

S&P 1500 Average Security Performance by Sector (2006 – 2015):

Don’t be misled by the different scales in these charts. The average healthcare stock in HealthCor’s portfolio returned a cumulative 330% compared to the average healthcare stock in the S&P 1500, which returned 180% cumulative over the same period! This must mean that HealthCor generates alpha by picking stocks that outperform their benchmark—in Novus terms that’s called Security Selection skill. Let’s test this with our attribution framework.

Our attribution framework splits returns into four distinct components on a security-by-security basis. First, we separate the portion of return attributable to general market direction. Then we do the same with the direction of the sector. What’s left is Alpha generated through selecting specific stocks within the sector (and trading around them). Since we’re working with public data and there’s a significant lag on filings, we don’t expect to pick up meaningful trading attribution, but we’ll leave it in as an unexplained portion of returns. What you get below is the Alpha created by picking stocks within healthcare.

Let me be very clear. We’re actually looking at Alpha, after the sector and market movement have been taken out. This chart shows that four thousands basis points of Alpha has been created by the manager over the years in healthcare, and that is a big number considering the recent volatility in the sector.

Breaking this down further, it’s very clear that the manager has benefited from their healthcare exposure in general. Even without the Alpha, they’ve added over seven thousand basis points to a portfolio with an equally weighted sector exposure to the S&P 1500. But of course it’s the alpha number that investors should focus on when selecting sector specialists, and in the case of HealthCor, that number is the reason they’re on our short list of top stock pickers in healthcare.

Conclusion

HealthCor is an example of a manager who knows what they’re good at and stick to it. Given the limited data set we used, we isolated a key driver to their Alpha—stock selection skill. It’s one thing to say you’re a great stock picker in healthcare, quite another to demonstrate it in a quantified way.

Now, the main questions for healthcare managers and their investors is this: after the recent turmoil in the space, do you stick to your guns and continue following your investment process, or do you shift focus? In this case, the evidence is clear—long term, the process employed by HealthCor produces massive amounts of Alpha in the sector. Having said that, Beta, or the direction of the markets—specifically around healthcare—is a lot harder to predict.