Rhenman & Partners

First class return generation through healthcare investing

Originally published in the March 2012 issue

Swedish national Henrik Rhenman studied biochemistry and began his career working in the engineering and pharmaceutical sectors for Pharmacia and Alfa Laval. In the early 1990s he was lured into finance, running one of the very first specialist pharmaceutical investment funds for Swedish bank Skandinaviska Enskilda Banken (SEB). While best-in-class performance won this product a Financial Times prize for best global equity fund in 1996, the stellar numbers did not percolate into Henrik’s own remuneration given the then rigid Scandinavian pay scales. This, along with personal reasons, spurred him to join Sweden’s ‘brain drain’ to seek more lucrative prospects in the U.S. Work with Boston-based healthcare specialists Cowen & Co. was prematurely arrested by Societe Generale’s takeover and the predator’s desire to cut overlap with its own Paris-based healthcare fund.

Henrik thus returned to his native Sweden far sooner than he expected, joining Carnegie in 1999 before it went public in 2001. In what was a booming market, they raised over $1 billion and delivered fantastic performance of 800% in nine years, a record that led the peer group and which might have made Soc Gen envious. As chief investment officer of the Carnegie Global Healthcare Fund and of the Carnegie Medical Fund, Rhenman looked for companies valued in the hundreds of millions that would grow into companies worth tens of billions. A scandal at Carnegie – completely unrelated to Rhenman’s fund – provided the impetus to strike out alone and set up his own shop, Rhenman & Partners Asset Management.The new fund, Rhenman Healthcare Equity L/S, launched in mid- 2009 and is up more than 44% since then and is up 7% for the first two months of 2012. Rhenman is unashamedly bullish, likening the current investment climate to 2003. He picks stocks from a universe of 500, of which 300 or so are in the US. Stocks need a minimum market capitalisation of $200 million. Though the fund will subscribe to initial public offerings, pre-IPO private equity is avoided. Liquidity criteria are that three quarters of the book cannot make up more than one quarter of average daily volumes. A 6% monthly loss forces risk reduction and value at risk – calculated independently by the administrator, European Fund Administration – is capped at 3% for one day with 95% confidence.

Rhenman splits the healthcare market into six sub-sectors: large pharmaceuticals; biotech; medtech; speciality pharmaceuticals; distribution; and services. All of these sectors are judged to be ripe with promising opportunities. In 1998, Johnson and Johnson traded on a price/earnings ratio over 30, now its on 11-12 – probably the lowest ever. Some large pharmaceutical companies are priced at seven times earnings and have huge dividend yields. Pharmaceutical benefit managers remain a growth story: distributing pharmaceuticals on behalf of employers, they use their buying power to get discounts.

While Rhenman does make trans-Atlantic trips to see companies, mainly in the US, he is usually office based. This raises the question of how can a Swede spending most of his time in Stockholm outperform much larger teams which may be closer to the US market action? Part of the answer is that plenty of firms drop by in Stockholm on their European roadshows. But what is also important is that Rhenman has a scientific perspective on research, a contrarian value bias and is an adroit shorter term trader.

Rhenman doesn’t feel he has any new insight into financial analysis, important though this is. Accounting metrics are easily obtained from the sell side. Physical, chemical and biological scientists are more influential than accountants for the fund. Its advisory board consists of five leading scientists. Chairman of Rhenman & Partners is immunology and vaccines academic Professor Hans Wigzell, a former Nobel Prize committee chair, and chief scientific adviser to the Government of Sweden who was recently decorated for scientific research by the Japanese government.

Wigzell also presided over the Karolinska Institute, which is one of Europe’s largest medical universities. It has fostered research alliances with Japanese academics and contributes three advisory board members. The Karolinska Institute is one of the largest medical universities in Europe, with roughly 4,000 employees and 6,000 students, and it awards the annual Nobel Prize in Physiology or Medicine.

The scientific advisers assess the likelihood of drugs passing clinical trials or the efficacy of new medicine treatments. The board have quarterly formal meetings, in addition to informal deliberations on a daily or at least weekly basis. The board have authored over one thousand articles in scientific journals with Wigzell alone having written more than 700. Their detachment from financial markets helps to reduce the chance of their views being swayed by market momentum. “The Scientific Advisory Board helps me assess the risks that are at hand for the healthcare companies we might invest in and they provide a kind of risk map that helps me navigate this very complex investment world,” says Rhenman.

The manager’s second alpha engine stems from his belief that the US market has become obsessed with quarterly sales and earnings momentum. This myopia leads to overly harsh share price punishment for companies that may only miss consensus estimates by a small (or ephemeral) margin. That creates the ideal entry point for longer term investors: there are nearly always opportunities to buy top quality companies after a near miss on earnings. Nearly every company has the odd weak quarter and Rhenman is not afraid to take a contrarian view and buy after a profit warning. Yet buy and hold long investing is far from the only source of returns. Rhenman’s third return turbocharger is trading around core positions, top slicing after a spike, and averaging down on the dips. Turnover is roughly 500% per year and approximately half of that comes from trading around key positions. The five biggest positions are traded more or less weekly with buying and selling based on fluctuations. Sometimes the fund trades intraday if news events warrant it. Shorting since 2009 has not yet added much but could become more important in the future. Options are occasionally used and may also become more important over time.

Emerging markets listed stocks are not behind the strong performance record. Instead, the trend is played through developed market listings such as Sanofi. This is one of the top five longs. Another is world HIV treatment leader Gilead: a defensive position due to the lifelong nature of HIV; it trades around 10 times earnings despite growth prospects not being vulnerable to slower GDP growth. Closer to home Norwegian biotech firm Algeta is pioneering the use of radioactive isotopes to target cancerous bone growths – without the toxic side effects of chemotherapy. Algeta’s partner Bayer has one of the best drug pipelines, and the fifth top holding, the world’s largest biotech Amgen, could also be revived by fresh product cycles.

The correlation at present among healthcare companies is extraordinarily high. Rhenman thinks he is likely to do best when wider stock dispersion improves opportunities for stock pickers. The Luxembourg domiciled fund started raising assets in the Nordic region and can approach institutions almost anywhere. For retail investors it is currently registered in Sweden and Luxembourg with a minimum ticket of €2,500. Rhenman needs sticky capital to take his contrarian views. Right now he feels volatility is a fair price to pay for not missing out on the next leg up – which could be perpendicular due to the record low valuations. “Either the world is approaching apocalypse, or we are due a massive rally, says Rhenman.

Last month Rhenman Healthcare Equity L/S was ranked #1 by Eurohedge among 52 global hedge funds in the category ”Global Equity EUR” based on the fund´s performance for the last 12 months (+17.19%). It was ranked #1 based on the fund´s performance for the last 3 months (+13.33%) and ranked #2 based on the fund´s annualised performance since inception (+14.18%) for funds with at least 2 year performance.