William Leland Edwards‘ Palo Alto Investors is a reputable fund with a strong focus and in-depth knowledge of healthcare stocks, a sector that accounts for more than 80% of its total holdings. The fund’s stock picks have performed well this year, thanks partly due to the continued strong growth in the healthcare sector as a whole. The hedge fund had 28 long positions in stocks with a $1 billion market capitalization as of March 31, and combined, those stocks delivered weighted average returns of 11.8% during the second quarter. That follows up on a monster first quarter for the fund using the same metric, pushing its year-to-date returns to 42.8%, and among the top performing funds in our database for the first half of 2015. It should be noted that the figure is only an approximation based on the fund’s long positions as of a certain date, and does not account for fluctuations in holdings, in addition to excluding other investment elements such as bonds and options. In this article, we are going to look into Anacor Pharmaceuticals Inc (NASDAQ:ANAC), AMAG Pharmaceuticals, Inc. (NASDAQ:AMAG), and Kythera Biopharmaceuticals Inc (NASDAQ:KYTH), three of the stocks that accounted for Palo Alto Investors’ strong stock-picking performance in the second quarter.
Most investors don’t understand hedge funds and indicators that are based on hedge funds’ activities. They ignore hedge funds because of their recent poor performance in the bull market. Our research indicates that hedge funds underperformed because they aren’t 100% long. Hedge fund fees are also very large compared to the returns generated and they reduce the net returns experienced by investors. We uncovered that hedge funds’ long positions actually outperformed the market. For instance the 15 most popular small-cap stocks among funds beat the S&P 500 Index by 81 percentage points since the end of August 2012. These stocks returned a cumulative of more than 139% vs. less than 59% for the S&P 500 Index (read the details). That’s why we believe investors should pay attention to what hedge funds are buying (rather than what their net returns are).
First, let’s look at Anacor Pharmaceuticals Inc (NASDAQ:ANAC), a biopharmaceutical company based in Palo Alto, California (I guess Palo Alto Investors was almost obliged to invest in them, weren’t they?), which makes anti-fungal and anti-inflammatory drugs. During the first quarter of 2015, Palo Alto Investors increased its stake in the company by 30% to 3.26 million shares valued at $188.54 million. The fact that the stock delivered 33.8% returns during the second quarter shows that Palo Alto Investors made a smart move to increase its stake in the company. The company’s earnings per share results have beaten analysts’ consensus forecasts in the past four quarters. The company is expected to launch Kerydin, a solution used in the treatment of toenail fungal infection and nail bed. The treatment was recently approved by the U.S. Food and Drug Administration. At the end of the first quarter of 2015, a total of 26 hedge funds out of the more than 700 that we track were invested in the stock. Julian Baker and Felix Baker‘s Baker Bros. Advisors was the biggest shareholder of those, having 4.20 million shares at the end of the quarter. Palo Alto Investments came second, followed by Anders Hove and Bong Koh’s VHCP Management with 1.18 million shares.