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Healthcare: A Stock Picker’s Dream and Nightmare

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Stockholm (HedgeNordic) – Trond Tviberg, one of the founding investment managers of Sector Asset Management’s healthcare-focused Gamma arm, embarked on a new venture after resigning from Sector in February 2021. Seeking a fresh challenge, Tviberg received an exciting proposition from Mads Andreassen, a former portfolio manager from the same Gamma team, to launch a new healthcare fund. Since September of last year, the duo has successfully managed Seior Healthcare Opportunities Fund, a low-net long/short equity fund specializing in the healthcare sector.

Reflecting on his then-surprising decision to leave Sector in February 2021, Tviberg recalls, “I needed a new challenge, a new start.” Seven months later, Andreassen, who had also left Sector in 2018 after being part of the same portfolio management team, approached Tviberg with an idea to launch a new healthcare fund. “Mads was the driving force behind the idea,” Tviberg affirms. Together with Are Søberg, the Chief Operating Officer at Seior and a member of the old team at Sector Gamma, the trio constituted 60 percent of the original team. Sector Gamma continues to run a market-neutral fund and a long-only fund specializing in healthcare.

The newly formed team began their project with a fundamental question: “What type of healthcare fund would we want to invest in?” The team decided against a market-neutral as conventional indicators of neutrality, such as beta, do not adequately capture systematic-like risk factors such as style exposures. Market-neutral strategies struggle to maintain neutrality across all phases of a market cycle and returns can suffer if certain styles fall out of favor.

“There is a lot of dispersion within this idiosyncratic risk-dominated sector, which means it can be a stock picker’s dream or nightmare.”

“We also decided that long-only was not an option either, as there was no downside protection,” explains Tviberg. “We wanted flexibility, which fits well with this sector, so we opted for running a quasi-directional long/short equity fund with a net exposure between zero and 50 percent,” he continues. “There is a lot of dispersion within this idiosyncratic risk-dominated sector, which means it can be a stock picker’s dream or nightmare.” The healthcare sector lends itself well to a long/short equity strategy and the Seior team leverages their experience managing both long-only and market-neutral funds in the healthcare sector to inform and improve their approach. “We took forward what worked and enhanced or solved what we thought were challenges,” says Tviberg.

Concentration, and Valuation Focus

Drawing from their experience running healthcare-focused funds at Sector, the team aimed to increase focus and concentration in the portfolio. From a universe of 400 healthcare companies globally, filtered by market cap above $1 billion and $5 million in daily liquidity, Seior Healthcare Opportunities Fund tends to maintain a portfolio with 20 to 40 long positions and 10 to 25 short positions.

“Everything starts from valuation.”

The Seior team places a strong emphasis on valuation, constantly seeking undervalued stocks for the long portfolio and overvalued stocks for the short side. “Everything starts from valuation,” emphasizes Tviberg. Research indicates that, as a rule of thumb, 80 percent of a healthcare company’s intrinsic value comes from existing product lines and 20 percent from the product pipeline. “We look for companies that have pipelines with negative implied value. We don’t take scientific or binary bets on a product in development. We make financial or product bets versus pipeline bets, considering the cyclical nature stemming from a product’s lifecycle.”

Earnings Revision Model

Mads Andreassen has also developed an earnings revision model that assists the team in making more accurate assessments of a company’s valuation and expected direction. “We aggregate different valuation models to identify potential alpha,” says Tviberg. “The earnings revision model and the measure of implied volatility of the underlying stocks play an important role in the portfolio construction process. We may place larger bets on larger, less volatile companies,” explains Tviberg.

While the “name” turnover is not very high, the team frequently trades around positions based on valuation levels and insights from the earnings revision model. “We are data-driven, process-oriented, but we are not running a quant strategy,” emphasizes Andreassen. Ultimately, the portfolio managers have the final say in the portfolio composition and net market exposure.

“We are data-driven, process-oriented, but we are not running a quant strategy.”

The team’s approach to short selling is also driven by valuation. “We employ a similar approach for both longs and shorts. But we are more prudent on the short side,” says Andreassen. “We don’t need to squeeze the last 10 percent out of a short bet. We may enter shorts slightly late and exit early.” The fund’s net exposure is primarily determined by bottom-up stock selection and guided by insights provided by the earnings revision model regarding the sector’s future earnings.

Sustainability Engagement

The healthcare sector gives investors the opportunity to support goal three of the UN’s Sustainable Development Goals: “Ensure healthy lives and promote well-being for all at all ages.” While the healthcare industry contributes to extended life expectancies, prosperity, and economic process, it also poses challenges for ESG investors due to issues such as drug pricing, affordability, lobbying practices, anti-competitive behavior, animal testing, or questionable clinical trials. This might be a tough pill to swallow for socially responsible fund managers and investors. The Seior team has found a way to integrate sustainability into its investment process.

“Our approach involves actively engaging with companies regarding sustainability.”

“Sustainability is an integral part of the evaluation process,” starts Andreassen. Seior Healthcare Opportunities Fund is classified as an Article 8 fund but does not shy away from investing in companies with low ESG scores. “Our approach involves actively engaging with companies regarding sustainability,” emphasizes Andreassen. “When we identify points of concern, we set up calls or meetings to engage with management teams. If management acknowledges the issues, is transparent about them, and is working to address them, we can still invest.”

Healthcare as an Exposure

Investing in the healthcare sector offers attractive opportunities due to steady demand, long-term growth prospects driven by demographic trends, continuous innovation, and technological advancements. “Healthcare is expected to grow at a higher rate of growth than the broader economy due to a number of structural trends such as demographics, lifestyle changes, innovation, and others. It also provides access to innovative companies at attractive valuations,” explains Tviberg.

Additionally, investing in healthcare also provides indirect exposure to emerging markets as many healthcare companies sell their products to these markets. “Investing in this sector offers a way to get exposure to emerging markets through large, safe companies,” elaborates Tviberg. However, investing in the healthcare sector also comes with risks, such as regulatory changes, clinical trial failures, pricing pressures, and competitive dynamics. “There are also headwinds, including political uncertainty in the U.S., and price pressure. It is an opportune time to invest in the healthcare sector when there is a combination of economic and political uncertainty.”

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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