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While the once-robust S&P 500 sputtered to a 9.1% decline in 2000, Norman Fidel's Alliance Health Care Fund/A (AHLAX) soared 31.4%. Launched in August 1999, the $400-million portfolio benefited from strong performance across the health care spectrum -- for example, the S&P Health Care Index rose 36.7% in 2000.
Fidel looks for health care companies that dominate their market niches and are undervalued. Looking ahead, he believes that managed care companies will thrive in an environment of increasing Medicare rates, and that the completion of the Human Genome Project -- the government-led project to "map" all the genes in the human genome -- will enable biotech stocks to flourish. Fidel recently trimmed back on big-cap drug makers due to their relatively high valuations.
Standard & Poor's Fund Advisor correspondent Palash Ghosh recently had the opportunity to speak with Fidel about the fund's strategy -- and the stocks and sectors he likes now. Edited excerpts from their conversation follow.
Q: How large is the fund?
A: At the end of 2000, the fund's assets totaled about $400-million and comprised 40 stocks. We typically keep 35 to 40 names in the portfolio.
Q: What kind of stocks do you look for? What are your buy criteria?
A: We invest primarily in health care and health care-related companies that can dominate their market niches and will outperform Wall Street's expectations. Different sub-sectors within health care go in and out of favor over time. For example, from 1996 to 1999, medical services stocks were out of favor because the government had cut back on Medicare reimbursement, and managed care companies were in the process of reducing the rates they paid to providers. Then in 1999, things brightened as the government raised Medicare reimbursement rates and managed care firms received very large rate increases. In 1998, in anticipation of this turnaround, we invested heavily in health service companies in some other funds and separate accounts that I run.
Q: What are the fund's top holdings?
A: At year-end 2000, the top ten stocks were Pfizer Inc. (PFE
), 7.3%; Schering-Plough (SGP
), 4.9%; Pharmacia Corp. (PHA
), 4.8%; Sanofi-Synthelabo, 3.5%; Medtronic Inc. (MDT
), 3.5%; Forest Labs (FRX
), 3.5%; American Home Products (AHP
), 3.4%; UnitedHealth Group (UNH
), 3.4%; Health Management Associates (HMA
), 3.4%; and Wellpoint Health Networks (WLP
Q: What are your sector weightings?
A: At year-end 2000, we had 42.8% in drugs; 21.1% in biotech; 18.2% in medical services; and 12.5% in medical products. Drug manufacturers are usually such huge companies that they dominate health-care stock indices, so our position in drug makers is not an overweight. Relative to the S&P Health Care Composite Index, we are overweight in medical services and biotech.
Q: Can you take some of your biggest stocks and discuss why they're in the fund?
A: UnitedHealth Group, a managed care company, is a leader in its field, and its stock soared over 100% in 2000. As managed care firms are enjoying robust increases in their rates, UnitedHealth consistently exceeds consensus earnings and revenue forecasts. Similarly, Wellpoint is another prominent managed care company receiving higher rates, enabling them to cover their cost increases.
Health Management Associates dominates medical services in rural hospitals -- they don't face much competition in their markets. They have delivered excellent growth, and they have the highest margins in the industry. This stock also appreciated close to 100% last year.
Q: As you're well aware, biotech stocks soared in 1999 and into early 2000, but have since crashed. What is your view of these stocks?
A: Biotech stocks are highly speculative -- when Nasdaq-type stocks are in favor, as they were in 1999 and early 2000, the biotech sector will excel. When the Nasdaq weakens, biotechs will also be under pressure. Consequently, biotech stocks behave more like high-tech stocks: the mood of the market -- not fundamentals -- determines their performance more than anything else. In March 2000, we had 26% of the fund's assets invested in biotechnology. We later reduced our position to about 12% because we felt valuations here got way too high. We moved that cash into drug companies, which at the time were out of favor and underpriced.
Despite the speculative nature of biotech stocks, we feel that the Human Genome Project, an extremely important scientific achievement, will dramatically impact the economics of the biotechnology industry. The real benefit from the sequencing of the Human Genome is that they can eventually use this information to develop drugs to combat myriad diseases and other problems. Given the nature of the drug industry and its inherent barriers to entry, bringing a drug to market can take 10 to 15 years. However, investors and the market will get excited when these companies get their products to clinical trials.
Q: What are some of your favorite biotech companies tied to the Human Genome Project?
A: We like companies that will eventually produce drugs related to genomic research -- like Human Genome Sciences (HGSI
) and Millennium Pharmaceuticals (MLNM
). These two firms are at the forefront of taking this genetic-based information and developing a formidable portfolio of patents, which will lead to the development of drugs and very profitable franchises.
Q: Which area in health care are you staying away from?
A: We shy away from health care companies like laser companies or diagnostic imaging manufacturers, which require large capital expenditures to buy their products. These types of firms tend to become vulnerable to the economy and are often subject to product obsolescence. We like companies that can sell their products quickly and relatively cheaply.
Q: What are your sell criteria?
A: We generally sell or scale back a stock when we feel it has reached its full price valuation or when we think fundamentals are deteriorating, based on our original investment assumptions.
Q: Can you cite a stock you recently sold off and why?
A: At the start of the new year we trimmed back our investments in our three largest holdings, Pfizer, Schering-Plough and Pharmacia, because we felt their valuations had become relatively high. From S&P FundAdvisor