The selloff in biotech stocks over the past month has hurt Justin Uyehara, one of my top managers who I think just might be one of our generations’ Warren Buffetts. Justin’s portfolio climbed 61% in 2013 but lost 10% in 2014 through April 4, which ranks him last among the four members of the Marketocracy Explore Team.
Last week, I decided to keep Justin on the Explore Team. You don’t bench someone with a 10-year track record that has averaged 30+% a year just because they have a bad quarter, but you also can’t let poor performance continue either. It’s a fine line to walk as a portfolio manager. To understand the prospect for a turnaround in Justin’s performance, I reviewed his portfolio with him. I wanted to get his perspective on what was going on in biotech and how it was affecting him.
Justin's top five holdings include an emphasis in biotech. His Marketocracy model portfolio has... [+]
My conversation with him was enlightening.
Ken Kam: Justin, you delivered a terrific return for our clients in 2013 -- almost double your 10-year average annual return -- but your performance this year puts you last among your fellow members on the Explore Team. What has changed?
Justin Uyehara: The market is punishing everything that went up a lot last year. For example, the Biotech index is going down after a big gain last year.
Ken Kam: In the past, when selloffs like this have happened, you’ve been quick to sell. This kept your losses small during the crash of 2008, but this time you didn’t do enough selling to avoid the downdraft. Why not?
Justin Uyehara: In 2008, when the financials were tanking, it was different. I was really concerned that the financial system could fall apart so I sold. This time, aside from Halozyme (NASDAQ:HALO), there have been no negative changes in the biotech stocks I own so I do not have the same concerns about these companies as I did about the financials in 2008. I did sell 50% of my holdings in HALO immediately after they voluntarily stopped their Phase 2 trial, but I didn’t sell it all because the drug is for pancreatic cancer, for which there aren’t many alternatives, and based on the survival data, it was trending toward a favorable outcome. I’m still optimistic on it. According to National Cancer Institute data, pancreatic cancer is the fourth leading cause of cancer deaths in the United States. Halozyme also has other drugs in the pipeline. It is not a one trick pony so it’s not going to zero.
Ken Kam: Why did the company stop the trial if the data was trending toward a favorable outcome?
Justin Uyehara: Halozyme said that it had temporarily stopped the trial at the recommendation of an independent safety board, which was assessing a possible difference in the rate of blood clots found in patients receiving Halozyme's treatment and those receiving approved cancer treatments. The study was testing a more potent form of the company's existing technology to deliver chemotherapy drugs intravenously and to prolong the effectiveness of its synthetic enzyme, Hylenex, in the blood stream. An analyst at Piper Jaffray said he expects the trial’s halt to be resolved in "weeks, not months.” If he is right, this stock could come roaring back.
Ken Kam: Besides Halozyme, you had three other stocks that got caught in the biotech selloff: Nektar (Nasdaq:NKTR), Sarepta (NASDAQ:SRPT), and Solazyme (NASDAQ:SZYM).
Justin Uyehara: Nektar is modifying an existing opioid to make it safer and less addictive. Sarepta has a platform for RNA based therapeutics. Solazyme is using algae to make highly valued oils that are not found in nature. In all three cases, there has been no change in the fundamentals to warrant the change in price, which is why I have not sold them.
Ken Kam: Why do you have such a large weighting in biotech stocks?
Justin Uyehara: I like Biotech stocks because their future is not determined by macro-economic issues that concern me, such as the Euro. The Germans do not want to pay for the mistakes of other countries, and the countries that need bailouts don’t want to give up any sovereignty. The result is that you have a large part of the world’s economy stuck in recession with a government that cannot do what it will take to get them out of recession. Since biotech stocks are not economically sensitive, they are a way to avoid exposure to this risk.
Ken Kam: Isn’t the downturn in biotech stocks the market’s way of saying you were wrong about these stocks?
Justin Uyehara: The downturn was caused by a change in market sentiment, not company fundamentals. If the downturn was due to deteriorating fundamentals, I would sell. But, since market sentiment is fickle, I am looking to take advantage of the lower prices I’m seeing for companies with great fundamentals.
Ken Kam: What do you think caused the change in market sentiment?
Justin Uyehara: I’m not exactly sure, but I think exchange traded funds (ETFs) have made biotech stock prices more susceptible to changes in market sentiment than in the past. There are now several biotech focused ETFs with assets that are many times the market cap of the typical biotech stock. When these ETFs are hit with large redemptions, the volume of selling they must do to raise cash can be many times the usual trading volume of a lot of biotech stocks. As a result, biotech stocks with good fundamentals but thin trading volumes can be swamped with sell orders even though nothing fundamental has changed. If I am right about the fundamentals on the stocks I hold, they should do well as the companies perform.
Ken Kam: Thank you, Justin.
Conclusion: Justin is exhibiting much more long-term conviction about these stocks than I am used to seeing from him. In the past, he has been quick to sell stocks when they turned against him even slightly. Being quick to sell and cut off losses has been a hallmark of his investment style. In the past couple of years, however, he and I have noticed that the stocks he has sold have often recovered quickly, raising the question as to whether or not he should be so quick to sell off every time.
Last year, being a little less quick on the trigger improved his returns by keeping him in stocks that did well after a setback and by reducing turnover. It is difficult to say just how long it might take for the biotech stocks to recover, but because of Justin’s track record and his compelling rationale for remaining invested in these stocks, I’m willing to wait and see what happens here.
Even after this setback, he has done a great job for clients who have been with him for at least one year. Clients who have not selected Justin for their portfolios at present might consider that the best time to add biotech stocks is after they have taken a beating. If the fundamentals are intact then the upside is still there, but the risk is lower because all the optimism has already been beaten out of the price.
You can view Justin’s top 5 holdings, learn more about his strategy, and track his progress with monthly Performance Insights.
The opinions expressed in these articles are general in nature and not specific to your financial situation. To discuss your financial objectives, connect with Ken Kam on LinkedIn.
Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
