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

 
 
 

33 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

 
Update
2

7 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 ...
Source: Business Times Singapore   Full article at: Business Times Singapore
 

 
Update
1

8 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 ...
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

China offers new anti-Ebola aid to West Africa
Beijing, Oct 24 (IANS) China will provide 500 million yuan (about $82 million) in aid to Liberia, Sierra Leone, Guinea and international organisations to fight the Ebola virus disease, Chinese President Xi Jinping said Friday.
 
 
India, China form Asian Infra Investment Bank
Beijing, Oct 24 (IANS) India Friday signed on to a China-led initiative to create an international bank to fund development of infrastructure essential for Asia's economic growth and reduce the dependence on Western-dominated World Bank and International Monetary Fund.
 
 
IS abducts three journalists in Iraq
Mosul (Iraq), Oct 24 (IANS/EFE) The Islamic State (IS) terrorist group Friday kidnapped three Iraqi reporters in the northern Iraqi city of Mosul, a human rights official told Efe news agency.
 
 
China launches test return orbiter for lunar mission
Beijing, Oct 24 (IANS) China launched an unmanned spacecraft early Friday to test technologies to be used in the Chang'e-5, a future probe that will conduct the country's first moon mission and return to the Earth.
 
 
 

Latest from the Network

Second MERS case reported in Qatar
Doha, Oct 23 (IANS) A 43-year-old man in Qatar has tested positive for Middle East Respiratory Syndrome (MERS) in the second confirmed case of the deadly virus in 10 days, media reported Thursday. The patient had...
Read more on Business Balla
 
Two people die in Pakistan bomb blast
Islamabad, Oct 23 (IANS) At least two people were killed and 12 others injured in an explosion that took place in Pakistan's Balochistan province Thursday, media reported. The bomb was planted on a motorcycle, Dawn...
Read more on Politics Balla
 
Trott extends contract with Warwickshire till 2017
London, Oct 23 (IANS) England batsman Jonathan Trott, whose mental issues led to his abrupt departure from last winter's Ashes tour, has confirmed his successful comeback to competitive cricket by signing a new three-...
Read more on Sport Balla
 
Srikanth, Kashyap big movers in BWF rankings
Kuala Lumpur, Oct 23 (IANS) Indian men shuttlers Kidambi Srikanth and Parupalli Kashyap jumped seven places each in the latest Badminton World Federation (BWF) rankings released Thursday while Olympic bronze medallist...
Read more on Sport Balla
 
Alvin Stardust dead
London, Oct 23 (IANS) English singer Alvin Stardust died after a short illness. He was 72. Stardust's manager confirmed the news about his demise Thursday, reports mirror.co.uk. He was recently diagnosed with...
Read more on Celebrity Balla
 
Indian man reunited with family after 40 years
Dubai, Oct 23 (IANS) An Indian man, who had disappeared from his hometown in Kerala nearly 40 years ago, has been found by his family at a hospital in Dubai in the UAE, a newspaper report said. Now in his 60s, Abdulla...
Read more on Politics Balla
 
Srikanth, Kashyap, Saina rise in world rankings
Kala Lumpur, Oct 23 (IANS) Indian men shuttlers Kidambi Srikanth and Parupalli Kashyap jumped seven places each in the latest released Badminton World Federation (BWF) rankings Thursday while Olympic bronze medallist...
Read more on Sport Balla
 
Flintoff signs for Big Bash side Brisbane Heat
Brisbane, Oct 23 (IANS) Former England captain and all-rounder Andrew Flintoff, who retired from international cricket in 2009, Wednesday confirmed that he will play for Brisbane Heat in the Big Bash League (BBL) this...
Read more on Sport Balla
 
OPEC daily basket price falls again
Vienna, Oct 23 (IANS/WAM) The basket of 12 crude oils of the Organization of Petroleum Exporting Countries (OPEC) closed at $81.94 a barrel Wednesday compared to $82.09 Tuesday, the OPEC Secretariat said. The new OPEC...
Read more on Business Balla
 
Lopez to sign multi-million dollar deal?
Los Angeles, Oct 23 (IANS) Singer-actress Jennifer Lopez is reportedly in the final stages of securing a multi-million dollar deal to perform in Las Vegas. The 45-year-old is being offered $350,000 per show at The...
Read more on Celebrity Balla