Platform companies have been having a rough go at it recently, the aggregate index of the holdings we track are collectively down 10.78% YTD.
A nickel ain’t worth a dime anymore – Yogi Berra
In mid-February, we posted this piece on Platform Companies, the exemplars of the bull market in equities over the last few years. These companies have been having a rough go at it recently, with the aggregate equal-weighted index of the holdings we track are collectively down 10.78% YTD, versus the S&P 500’s 1.74% gain, through April.
In particular, the Pharma roll-up names have detracted the most alpha, led by Valeant Pharmaceuticals (NYSE: VRX), Endo International (NYSE:ENDP), Perrigo (NASDAQ:PRGO), Allergan (NYSE:AGN), Horizon Pharma (NASDAQ:HZNP), and Concordia Healthcare (NASDAQ:CXRX). These undoubtedly reflect a combined change in the political environment regarding prescription cost increases, as well as this government’s acquiescence toward offshore tax inversions.
Hedge funds in many ways follow the opportunity set for asymmetric risk/reward. We’ve discussed in the past how the alignment structure of a GP/LP can skew the assessment of risk compared to reward, but the data with these platform companies clearly shows a trend of crowding in these names that is in many ways a lagged but much more rapid phenomenon in relation to the aggregate hedge fund industry’s crowding trend:
Note the acceleration in crowding score (grey, left axis) from late 2012 through 2014, as these companies saw tremendous increases in ROIC. Given that their business models are predicated on implicit financial leverage, it may seem logical to conclude that aggregate hedge fund crowding into the names fueled and extended their market performance – potentially exacerbating there retracement.
It’s also interesting to note that the crowding score for hedge funds peaked after the composite of stocks began to crack. The stocks reached their zenith in mid-July of 2015, whereas the crowding score of the composite rose from the September 2015 through the December 2015th filings, indicating additional crowding in the 4th quarter when the music had (apparently) already stopped.
This is not to say that all of these companies are faring as those pharma-rollups have. Several, such as Post Holdings (NYSE:POST), Jazz Pharmaceuticals (NASDAQ:JAZZ), and Spectrum Brands Holdings (NYSE:SPB) have generated alpha in 2016. The question is whether these have been dead cat bounces in the recent rally, or if they will extend out of their recent malaise:
This week, we will be privy to an update of aggregate Hedge Fund filings in these companies. With that, we will be able to posthumously update any relevant data as of March month-end. Additionally, as more of these companies file earnings, we will be able to update metrics such as lookthrough leverage, EV/EBITDA and balance sheet debt. What we know from extrapolating the 12.31 filings through April is that these companies have been some of the biggest alpha detractors in our hedge fund universe. We will have an updated piece detailing these particular stocks in the coming weeks.
At Novus, we are firm believers in investing in skill and its tangible benefit over perception and a recency of returns. Our roots lie in hedge fund allocating, and we’ve witnessed several regimes of evolution in the space. Our research clearly shows that alpha generation is harder than it was 10 or even 20 years ago. Rather than abandoning active management, we believe internal tooling, process, and self-reflective analytics are more important than ever. In a world of scarce extrinsic alpha, Institutional Investors (and by extension managers) must manage intrinsic sources of alpha.
In this report, we outline several concepts around mean-reversion, the need for better GP/LP alignment, diversification benefit of assets, and true measurement of performance to help Institutional Investors grapple with this ‘New Normal’ in hedge fund allocating.
Download our latest report to learn more.Published on May 17, 2016