Manager Monday: Deerfield
Every Monday, we dive into the public holdings of a major hedge fund manager. Learn how Deerfield has outperformed in the latest post.
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.
In a recent report that identifies the industry’s top stock pickers, Deerfield made the top 10 list for the Healthcare sector. We also track the manager in our Tiger Cub overlap matrix, due the founder Arnold Snider’s long tenure at Tiger Management. We have decided to take a detailed look at what drives this manager’s success.
How Has Deerfield Performed?
Since 1999 their simulated returns have been very strong, handily outpacing the S&P 1500 Healthcare index as well as the broader markets. The long side simulation of the fund annualized at 17.9% compared to 7.8 for the sector benchmark since 1999. More recently the fund has widened the performance gap as can be seen in the cumulative returns chart below.
While they have achieved these returns with higher volatility than the market, surprisingly they have been able to curb their drawdowns in times of market stress as witnessed by lower drawdowns in the following chart.
Deerfield’s Attribution and Skill
Over the last 15 years, Deerfield has participated in 787 securities and 63% (Box 1) of them have had positive P&L, a batting average in line with that of the general market. They have been able to deploy capital efficiently as 73% (Box 2) of the value of the portfolio has been allocated to winners. This contributed to a strong win/loss ratio since the average winner made almost 3x of that the average detractor cost (Box 3).
The win/loss ratio is defined as the average contribution from your winning positions divided by the average loss from your losing positons. In laymen’s terms, it’s how much you make when you’re right versus how much you lose when you’re wrong. A high win/loss ratio is very important to active managers and is achieved either by timing trades well, by sizing positions right, or in some cases, both.
Let’s expand on the two concepts. One way to have a strong win/loss ratio is by riding your winners (hold them longer) and cutting your losers (sell them quicker) before they cause any serious damage to P&L. Another way is to size your positions right – position sizing skill shows when your highest allocation investments tend to have higher ROIC than your smaller allocations (on average). Interestingly, it is the former, not the latter that is driving the win/loss metric for Deerfield as their simulated performance is very similar to its equal-weighted scenario.
Since Deerfiled is a Healthcare focused fund, we expect most of the contribution to come from that sector. This is indeed the case, but let’s take a deeper look to see what’s driving the return within the sector. The table below decomposes the P&L from the Healthcare sector into four distinct components: P&L attributable to Market, Sector, Security Selection, and Trading (trading is mostly negligible when using public data due to the low frequency of filings). We can see that almost half the P&L in the sector actually came from stock picking alone! That’s quite a feat and has earned them their spot on the top 10 stock pickers list in Healthcare.
Another interesting observation from the attribution analysis is that their contributors are fairly evenly spread out without any major outliers. We have mentioned before that many hugely successful managers owe their success to a handful of positions that they sized extremely well. Not so with Deerfield. Their contributors are diversified and evenly sized. Take a look at their largest winners over the years and notice the position sizing on the right, most are in the 1-5% range. This can be taken as strong evidence of consistent stock picking skill. Since the manger participated in a large number of positions, the sample set for the analysis is quite robust and makes the average outperformance numbers more statistically significant.
Deerfield is Unique
The most interesting thing about Deerfield apart from their performance might be the stocks they are NOT invested in. They are the most unique healthcare manager in our group of 50 Tiger Cubs and indeed, one of the most unique mangers in general. Almost 60% of their public healthcare portfolio is not owned by any other Tiger Cub. They chose to shy away from the top five most popular names in healthcare: Actavis (most popular name in hedge funds), Valeant, Endo Health, Illumina and Alnylam Pharma are all absent from the Deerfield portfolio. In addition, the popular names that are owned by Deerfield happen to be smaller allocations in their portfolio, explaining their relative uniqueness.
The brief analysis we conducted on the Novus platform shows how Deerfield was able to consistently outpace their peers and their benchmarks. They have done this primarily through stock-picking ability in the healthcare sector. In addition, they seem to choose unique names not widely followed by other similar managers playing in Healthcare, but still greatly outperform the broader market and sector.
How are your managers generating alpha? Is it stock picking, position sizing or something else entirely? Todays most sophisticated investors use the Novus platform to monitor skill and risks as they change and evolve over time. Join them. Learn more about Novus at Novus.com