If you aren’t an expert in evaluating hundreds of tiny biotech and healthcare companies, this newsletter is for you. We share hedge funds’ top 10 micro-cap ideas every quarter as well as 5 additional ideas based on healthcare hedge funds’ investor letters.
We believe an area of the market where hedge funds’ resources may help them beat the market is micro-cap healthcare stocks. Most investors don’t have the expertise to understand what these companies –many of which are biotech stocks- try to accomplish and whether they can actually do that. We believe hedge funds are better equipped at judging the future potential of these microcap stocks. So, we decided to do some back-testing using the same database and the same methodology that we used to develop our quarterly small-cap hedge fund strategy that we share in our quarterly newsletter. The only differences in the methodology are that we restricted our analysis to healthcare stocks and we included only those stocks that have more than $100 million and less than $1.5 billion in market cap.
On average, the 10 most popular micro-cap healthcare stocks managed to outperform the S&P 500 Total Return Index by an average of 207 basis points per month between 1999 and 2012 (their average return was 240 basis points per month vs. 32 basis per month for the S&P 500 Total Return Index). This was a very good period for healthcare stocks which is why we used sector returns as well as Carhart’s 4 factors to adjust these returns for risk. Our calculations showed that these stocks still managed to generate a monthly alpha of 112 basis points (this is about 32 basis points per month more than the alpha generated by our small-cap hedge fund strategy in back tests covering the same period).
We also calculated the returns of these 10 most popular micro-cap healthcare stocks between the end of August 2012 and the end of March 2015. These stocks returned 125.8% during this period but healthcare stocks in general were again strong performers during the same period. PowerShares S&P SmallCap Health Care ETF (PSCH) gained 95.9% whereas S&P 500 ETF (SPY) returned only 54.7% during the same period. These results are extremely encouraging, which is why we decided to share the stock picks of this strategy in our rebranded Monthly Healthcare Newsletter.
Our monthly newsletter also shares 5 ongoing “best ideas” that are picked from hedge funds’ investor letters. Currently all of these 5 picks come from Sio Capital’s investor letters. Sio Capital returned 20.1% in 2014 vs. 13.7% gain for the S&P 500 Total Return Index. In 2015 (through September) Sio Capital returned 8.9% vs. a loss of 5.3% for the S&P 500. We will be including stock picks from other hedge funds in the coming issues.
Finally, in 8 out of the 12 issues of our monthly newsletter we also focus on a single hedge fund and analyze its historical 13F filings to determine the best way to imitate that hedge fund. Why pay a hedge fund manager an arm and a leg when you can generate better returns by imitating his best picks (and avoiding his mediocre picks)!
We should warn our subscribers that healthcare stocks have been outperforming the market for a very long time and they may continue to do so for the foreseeable future. However, it is also possible that the entire sector may experience significant declines. Additionally, individual stocks -especially biotech stocks- may lose their entire value in a very short amount of time even in a rising market. Please keep this in mind when deciding how much to allocate to this strategy and each individual position.