VHCP Management Produced Impressive Returns From Its Pharma Stock Picks In The Turbulent Third Quarter

With losses in the high single-digits and volatility hitting the roof, the third quarter of 2015 turned out to be a troublesome period for the equity markets. While a lot of asset management firms suffered serious setbacks during this period, there were a few who not only lived through it with minimum damage, but were also able to generate superior returns. Andres Hove and Bong Koh’s healthcare-focused hedge fund VHCP Management was one such firm. We calculate the stock picking performance of a hedge fund based on the weighted average returns of its picks in companies with market capitalizations of over $1 billion. As we don’t take into account short positions or positions in bonds or options, it is possible that the returns estimated by us differ greatly from the actual performance of the fund. Based on this metric, VHCP Management’s picks returned 17.38% for the third quarter and 58.5% for the first nine months of 2015. To put that in perspective, out of 649 funds in our database for which we calculated third quarter returns, the next-best performance stood at just 2.88% for the third quarter and just seven funds generated positive returns from their stock picks during that period, using our method of calculations. Given that, in this article we are going to take a closer look at VHCP Management’s top five equity holdings at the end of the second quarter and figure out which of them played a key role in the fund’s spectacular performance during the third quarter.

Venrock Healthcare Capital Partners, L.P. (VHCP) was founded as a venture capital arm of the Rockefeller family by Laurence S. Rockefeller in 1969. Although the firm mostly invested in technology companies in its early years, over the course of time it gyrated towards investing primarily in publicly-held, development-stage and late-stage private healthcare companies. VHCP Management is currently managed by partners Andres Hove and Bong Koh. While Mr. Hove served as the CEO of Bellevue Asset Management prior to joining VHCP in 2004 and holds an M.B.A. from INSEAD, Mr. Koh boasts an M.B.A. from Harvard Business School and prior to joining VHCP in 2009 was an active investor in public and private markets since 2004.  At the end of June, VHCP Management’s U.S public equity portfolio was worth nearly $354.5 million and all of it was invested in healthcare companies.

We pay attention to hedge funds’ moves because our research has shown that hedge funds are extremely talented at picking stocks on the long side of their portfolios. It is true that hedge fund investors have been underperforming the market in recent years. However, this was mainly because hedge funds’ short stock picks lost a ton of money during the bull market that started in March 2009. Hedge fund investors also paid an arm and a leg for the services that they received. We have been tracking the performance of hedge funds’ 15 most popular small-cap stock picks in real time since the end of August 2012. These stocks have returned 118% since then and outperformed the S&P 500 Index by over 60 percentage points (see the details here). That’s why we believe it is important to pay attention to hedge fund sentiment; we also don’t like paying huge fees.

Let’s start with VHCP’s largest equity holding at the end of the second quarter, Anacor Pharmaceuticals Inc (NASDAQ:ANAC). As of June 30, the fund held nearly 1.18 million shares of the company, worth $91.25 million. Owing mostly to the over 50% gains that Anacor Pharmaceuticals Inc (NASDAQ:ANAC)’s shares enjoyed on July 13 after the company announced promising results from late-stage (phase III) studies done on its topical skin ointment, ‘ Crisaborole’, shares of the company ended the third quarter with gains of 52% and are currently trading with year-to-date gains of 270%. On September 9, analysts at JMP Securities initiated coverage on Anacor’s stock with a price target of $173, which represents a potential upside of 47.8% from the stock’s current trading price. Among the hedge funds we track, Julian Baker and Felix Baker‘s Baker Bros. Advisors was the largest shareholder of Anacor Pharmaceuticals Inc (NASDAQ:ANAC) at the end of the second quarter, owning over 3.62 million shares.

Although VHCP’s second-largest equity holding on June 30, GW Pharmaceuticals PLC- ADR (NASDAQ:GWPH), lost 25% during the third quarter of the year, it is still trading up by 31.58% year-to-date thanks to the rally it saw during the first half of the year. The fund held 311,853 shares of the company at the end of June, valued at $38.31 million. The U.S FDA recently approved GW Pharmaceuticals PLC- ADR (NASDAQ:GWPH)’s request for a trial of its pharmaceutical grade Cannabidiol (CBD) drug, Epidiolex. Most analysts that cover the stock have a ‘Buy’ rating on it, with the consensus price target standing at $144.40. Billionaire investor David E. Shaw‘s firm D.E. Shaw owned 23,483 shares of GW Pharmaceuticals PLC- ADR (NASDAQ:GWPH) at the end of second quarter.

Moving on, VHCP Management owned almost 1.01 million shares of Heron Therapeutics Inc (NASDAQ:HRTX) at the end of June worth $34.14 million. After more than doubling in the month of June, shares of Heron Therapeutics Inc (NASDAQ:HRTX) remained largely flat during the following two months. However, the volatility in September caused them to end the third quarter down by nearly 20%. Nevertheless, the gains made in June has ensured that they are still trading up year-to-date, by over 150%. On September 23, shares of the company saw massive gains of over 25% after it released positive top-line data for its experimental pain medicine, HTX-011, from a mid-stage study. Christopher Medlock James‘ Partner Fund Management was one of the hedge funds that initiated a stake in Heron Therapeutics Inc (NASDAQ:HRTX) during the second quarter, buying over 1.8 million shares.

Avalanche Biotechnologies Inc (NASDAQ:AAVL) is the only stock among VHCP Management’s top five equity holdings that is trading down for the year. At the end of June, VHCP owned over 1.38 million shares of the company, worth $22.45 million. The nearly 50% decline that shares of Avalanche Biotechnologies Inc (NASDAQ:AAVL) endured in the third quarter, after they had already fallen by more than 50% in June has caused the company to lose over 85% of its market capitalization in 2015. The company is currently facing a securities class action lawsuit from its shareholders, who have alleged that it issued materially misleading business information concerning its Phase 2a of the AVA-101 study. Even though its shares slumped heavily during the second quarter, several hedge funds covered by us either initiated or increased their stakes in Avalanche Biotechnologies Inc (NASDAQ:AAVL) during that period. Among them was Israel Englander‘s Millennium Management, which increased its stake more than eight-fold to 984,884 shares.

Finally, we come to VHCP Management’s fifth-largest equity holding, Zafgen Inc (NASDAQ:ZFGN), in which the fund held 541,480 shares worth $18.75 million as of June 30. Shares of Zafgen Inc (NASDAQ:ZFGN) have remained highly volatile throughout the year, but are currently trading with year-to-date gains of 13.6%. On September 28, the company announced that Robert Perez and Geoffrey McDonough, M.D., will be joining its Board of Directors. Analysts at Leerink Swann, who have a $61 price target on the stock, reiterated their ‘Outperform’ rating on it on October 6. Among the hedge funds we track, James E. Flynn‘s Deerfield Management was the largest shareholder of Zafgen Inc (NASDAQ:ZFGN) at the end of the second quarter, owning slightly above 1.0 million shares.

Disclosure: None