How Hedge Funds’ Top Healthcare Bets Performed in Q1

Although the biotechnology sector was the most profitable sector in 2015, biotech stocks suffered the same fate as most others during the first quarter, having been hit by a strong selloff. The sector has been plagued by controversy, unrest, and concerns following the notorious 5,000% price increase for an old anti-infective drug foisted upon the public by Martin Shkreli’s Turing Pharmaceuticals. That spurred politicians like Hillary Clinton to vow to take action against such practices and even drug pricing in general, casting a pall over the industry that has yet to lift. There is also a mega merger on the books that has attracted a large number of investors and arbitrageurs, yet even that seemingly bound-to-be-successful event took a big hit yesterday when new tax regulations were proposed by the Treasury Department which would negate the financial benefits of tax inversions. Let’s take a look at five of the most popular biotech stocks and see how they fared during the first quarter amid this gloomy backdrop.

Our backtests showed that the 15 most popular small-cap stocks among hedge funds managed to generate a monthly alpha of 81 basis points, versus an alpha of 0.7 percentage points posted by their top 50 large-cap picks (see more details here).

Currently in the midst of a monstrous merger deal, Allergan plc Ordinary Shares (NYSE:AGN) and Pfizer Inc. (NYSE:PFE) have been the subject of intense speculation, as U.S legislators are looking to curb the trend of U.S companies buying foreign groups in order to change their tax domicile and reduce their tax bills. It is safe to speculate that Pfizer was particularly interested in acquiring Irish drug manufacturer Allergan for $160 billion for just such a tax inversion purpose. Although it seemed like the deal would not be able to be stopped in time, the U.S Treasury has now taken bold measures against tax inversions that could jeopardize the merger of the two pharmaceutical giants. The tax law loopholes that allowed for significant benefits from tax inversions have been removed and additional measures have been taken to prevent foreign companies from loading their U.S subsidiaries with debt in order to reduce their tax bill. Allergan shares fell off a cliff after the news broke, having opened 17% lower this morning, while Pfizer inched up by approximately 2% as arbitrageurs were likely closing their short positions. The Irish drugmaker had fallen by 14% during the first quarter, while the value of Pfizer shares fell by 7.3% during the same period.

It is yet unclear whether the deal will be quashed, as Pfizer could follow through with the takeover regardless. Should the merger fail, Allergan will be due a $3.5 billion “break up fee,” which should help it to ease its debt burden, so the news is not all bad. The company is also set to receive $40.5 billion from the sale of its generic drug unit to Israeli drugmaker Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA).

Allergan plc Ordinary Shares (NYSE:AGN) is the most popular stock among the hedge funds followed by Insider Monkey, with 159 of them having reported a stake in the company as of the end of the fourth quarter. Tiger Cub Andreas Halvorsen holds a sizable position as of that time, although he chose to reduce it by 17% over the quarter to 5.98 million shares. Billionaire John Paulson is also invested in the company, with his eponymous fund having reported ownership of 5.53 million Allergan shares as of the end of December.

Ken Fisher is betting big on Pfizer Inc. (NYSE:PFE), having increased his stake by 2% over the fourth quarter to amass more than 32.3 million shares, a position valued at more than $1.00 billion. Lee Ainslie also has high hopes for the stock, having more than 5% of his public equity capital invested in it. According to its latest 13F filing, Mr. Ainslie’s Maverick Capital holds 11.3 million Pfizer shares, up by 63% over the fourth quarter. Hedge funds like Pfizer Inc. (NYSE:PFE) overall and their sentiment towards the company also improved during the fourth quarter, with the total number of long positions having increased to 109 at the end of December from 97 a quarter earlier.

We’ll run through three more of hedge funds’ favored healthcare stocks on the next page.