360° Coverage : Hedging Strategies in a Hot Biotech Market (Secrets of the Buy...

2 Updates

Hedging Strategies in a Hot Biotech Market (Secrets of the Buy Side)

Mar 5 2014, 9:20am CST | by

For fun, go to your Bloomberg terminal and pull up a chart for Curagen (CRGN), then type in “GPO M”. This will bring up a price chart from 1998 until the company was acquired by Celldex (CLDX) in...

Filed under: news


27 weeks ago

Hedging Strategies in a Hot Biotech Market (Secrets of the Buy Side)

Mar 5 2014, 9:20am CST | by

For fun, go to your Bloomberg terminal and pull up a chart for Curagen (CRGN), then type in “GPO M”. This will bring up a price chart from 1998 until the company was acquired by Celldex (CLDX) in 2009. Focus on the period from 2000 to 2002.

This is everyone’s biotech bubble nightmare right now.

Is the biotech sector in a bubble? I claim no competence in gauging the wisdom – or whatever you call it – of the masses.

Is the sector “hot?” Undoubtedly.

So what do we do to prevent our portfolios from doing a Curagen?

Protecting stock gains is not as simple a process as one may think (nor is profiting from the reversal of what may be a bullish market for that matter.) You don’t want to depress the price of your stocks by selling your own position, something that portfolio managers face when they own a large position in a relatively illiquid name. Second, while tax considerations should not override fundamentals in trading decisions, they should not be ignored. The United States tax code gives us incentives to hold positions for more than one year, because the tax on capital gains is substantially less than the tax on short-term gains. Third, none of us wants to be overcautious. For those of us who invest based on fundamentals, one stock at a time, we should not overestimate our ability to predict large sector movements when that type of prediction is not a core competence.

So what do we do to prevent our portfolios from doing a Curagen?

One possibility is to ignore everything I said two paragraphs back and take a large short position in a sector index fund or exchange traded fund (ETF). This makes sense insofar as a big downward movement in the biotech or life sciences sector will be reflected in poor performance of the index or the ETF.

The problem with that strategy is that sector indices are often poor reflections of your underlying portfolio. If I were to try to hedge my portfolio, which consists of approximately 40 small and microcap names, with a sector index or ETF, I would be hedging small cap with large cap. The available indices for biotechnology are disproportionately weighted with companies like Gilead (GILD), Biogen Idec (BIIB), Celgene (CELG) and Amgen (AMGN). These stocks move in very different ways than my predominantly pre-revenue, early-stage, small-cap names. This trade could easily blow up if, whether or not the market for biotech rose or fell, a megamerger of a large pharma company and one of a large biotech companies were to occur, or if a company like Alexion (ALXN) were to be acquired. Further, the cash flow positive names that populate the indices are easy to fit into the discounted cash flow equations that analysts rely upon for price targets. This results in stock price movements that remain confined to more narrow bands than the price movements of my small cap names.

So how about choosing a portfolio of the similarly market cap weighted names that we think are fundamentally weaker, selling those names short, and moving to a more normal market neutral portfolio where our short exposure matches are long exposure?

This theoretically sound strategy, like the index hedging strategy we discussed, is much more difficult in practice than in theory.

Without naming any names, we all know companies whose weak fundamentals seem to disconnect from their share price performance. The stock market is an irrationally irrational place, and expecting engineering-type cause-and-effect relationships is an exercise in frustration. This is a particularly acute problem when identifying small company stocks to sell short. The most disastrous long position will lose 100% of its value, assuming it was bought without leverage (a rule that I feel every small cap investor should follow.) A disastrous short sale, on the other hand, is truly a house on fire.

The market can irrationally price a stock at five dollars a share, and then cruelly punish those rational value investors who, clutching their worn copies of Benjamin Graham’s “The Intelligent Investor,” short the stock at 5 and watch the market irrationally push stock price to 10, or 15 or higher. And, unlike a long position which grows less painful as it goes against you since each percentage movement in the wrong direction chips away at shrinking principle, a short position gets more and more and more painful the longer it stubbornly refuses to go by the book.

Even we fundamental investors try to avoid short squeezes.

So you want to know what to do to prevent your portfolio from doing a Curagen?

Part two to come.

(By the way, I don’t mean to pick on Curagen, which was actually founded by brilliant people and did some good for the world during its corporate life. I just needed a scary chart from a company that no longer trades.)

Source: Forbes Business


2 weeks ago

Khazanah throws MAS RM6b lifeline

Aug 29 2014 5:01pm CDT | Source: Business Times Singapore

August 30, 2014 1:15 AMKHAZANAH Nasional will inject RM6 billion (SS$2.4 billion) over three years to resuscitate loss-making Malaysia Airlines (MAS) under a recovery plan that includes even an Act of Parliament. Other key moves are migrating its operations, assets and liabilities to a new company (NewCo) and slashing the workforce of 20,000 ...
Source: Business Times Singapore   Full article at: Business Times Singapore


2 weeks ago

MAS posts loss of RM307m for Q2

Aug 28 2014 5:00pm CDT | Source: Business Times Singapore

August 29, 2014 1:13 AMMALAYSIA Airlines (MAS) registered a loss of RM307 million (S$122 million) for the second quarter to end-June, but warned of worse to come in the second half when the "full financial impact of the double tragedies of MH370 and MH17 ...
Source: Business Times Singapore   Full article at: Business Times Singapore


Don't miss ...


<a href="/latest_stories/all/all/30" rel="author">Forbes</a>
Forbes is among the most trusted resources for the world's business and investment leaders, providing them the uncompromising commentary, concise analysis, relevant tools and real-time reporting they need to succeed at work, profit from investing and have fun with the rewards of winning.


blog comments powered by Disqus

Latest stories

Chip in to enhance links, president tells Indians in Vietnam
Ho Chi Minh City, Sep 16 (IANS) The Indian diaspora in Vietnam can play a "significant role" as a "bridge" in deepening relations between the two countries, President Pranab Mukherjee said Tuesday.
Ho Chi Minh City's rise as economic hub marvellous: President
Ho Chi Minh City, Sep 16 (IANS) Lauding the perseverance and success of the people of Vietnam, President Pranab Mukherjee Tuesday expressed admiration at how Ho Chi Minh City has transformed into a prosperous regional economic hub.
Modi government improved economy, India's global image: President
Ho Chi Minh City, Sep 16 (IANS) In a departure from custom, President Pranab Mukherjee Tuesday largely abandoned his prepared speech to the Indian community in Vietnam and instead extolled the Narendra Modi government for its steps to improve the economy and burnish India's global image.
China, Sri Lanka ink $1.63 bn currency swap deal
Beijing, Sep 16 (IANS) China's central bank announced late Tuesday that it has signed a 10 billion yuan (about $1.63 billion) currency swap deal with the Central Bank of Sri Lanka.

Latest from the Network

In Ho Chi Minh City, president extols transformation, praises Modi (Roundup)
Ho Chi Minh City, Sep 16 (IANS) Visiting Vietnam's business capital on the penultimate day of his state visit, President Pranab Mukherjee Tuesday extolled the city's transformation to a regional economic hub after a...
Read more on Politics Balla
Ukraine grants self rule, amnesty to rebels
Kiev, Sep 16 (IANS) Ukrainian parliamentarians Tuesday granted self-rule to parts of two eastern regions -- Donetsk and Luhansk, and an amnesty to pro-Russian rebels, BBC reported. The law, affecting the two regions,...
Read more on Politics Balla
Daniel Radcliffe, Ben Kingsley and Brie Larson join 'Brooklyn Bridge' cast
Ben Kingsley and Brie Larson have joined the cast of 'Brooklyn Bridge'. Douglas McGrath has written and will direct the historical drama which has been inspired by true events during the construction of the Brooklyn...
Read more on Movie Balla
New Jack Reacher film promises to be 'three-hander in terms of audience appeal'
Chris McQuarrie will not be directing the next Jack Reacher film, according to Lee Child. The 59-year-old author has revealed the director of the first movie, which starred Tom Cruise as the protagonist, will not have...
Read more on Movie Balla
Eva Mendes gives birth to baby girl
Eva Mendes has reportedly given birth to a baby girl. The 40-year-old actress and her boyfriend Ryan Gosling, 33, welcomed their daughter into the world in Los Angeles last Friday (09.12.14), according to UsMagazine.com...
Read more on Celebrity Balla
A8 SoC Reportedly Including Hexa-Core PowerVR GPU
The users of the iPhone 6 are enabled to enjoy playing game with a high resolution, as a new report claims that the SoC of the A8 processor contains the new PowerVR graphics processing unit.According to Apple Insider,...
Read more on Apple Balla
The Application of the NFC being Limited to Only Apple Pay
Apple once again restricts the use of a key component of its smartphone, as the NFC is said to be only applied in the services of Apple Pay.According to CNET, the matter has been confirmed by a spokesperson from Apple....
Read more on Apple Balla
will.i.am designs Lexus NX car
will.i.am has designed a car. The Black Eyed Peas frontman has mixed music with motors for his latest project by teaming up with Lexus Europe to design the Lexus NX, and he has now appeared in their advert for the...
Read more on Celebrity Balla
Demi Lovato's whiffy fan encounter
Demi Lovato was farted on by a fan at a meet and greet. The 'Skyscraper' singer was left recoiling in horror when one of her supporters was so overwhelmed at the thought of meeting her, they let out some ''rotten'' wind...
Read more on Celebrity Balla
Big Sean has great chemistry with Ariana Grande
Big Sean and Ariana Grande have ''great chemistry''. The rapper has been dating the 'Problem' singer for two months but has been a big fan of her musical talents for some time. He said: ''Me and her make a lot of music...
Read more on Celebrity Balla