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Advisors: Be Careful What Funds You Choose

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What goes up must come down. And when stocks in the high risk biotechnology sector fall, they often do so spectacularly, dragging down everything within close proximity.

Such is the case with Valeant Pharmaceuticals International (VRX).  The $9.8 billion Quebec-based company is a former biotech hotshot, whose stock price has crashed almost 90% over the past eight months alone. By comparison, the Nasdaq Biotech Index (IBB) has fallen around 25% over that same time frame.

Valeant’s fall from grace has stung some of Wall Street’s best known portfolio managers and funds.  

Bob Goldfarb, the CEO and co-manager of the once revered Sequoia Fund (SEQUX) stepped down from his post last week. Sequoia held 12,803,392 shares of Valeant or 19.31% of its assets at the end of last year, making it one of Valeant’s largest shareholders among mutual fund companies, according to Morningstar.

The fact that such a well-regarded company like Sequoia could get snake bitten by an errant stock selection like Valeant has caused shockwaves throughout the industry.  

Sequoia was once recommended by Warren Buffett and outperformed the U.S. stock market for over four decades. Despite its historical pedigree, the $5.5 billion fund has been clobbered with a 30% loss over the past eight months and was downgraded by Morningstar.

Other mutual funds with large ownership stakes in Valeant like the First Eagle Fund of America Y (FEAFX), T. Rowe Price Health Sciences (PRHSX) and Davis NY Venture (NYVTX) have been hurt too.  

Valeant is being assaulted from a seemingly endless parade of regulators, politicians, and jittery markets.

The company is currently facing an SEC probe. It’s also been accused by U.S. lawmakers for price-gouging its specialty drugs and it has reduced its 2016 revenue forecast by 12%. Furthermore, the company warned that a delay in its annual report filing could trigger the risk of a debt default.

On the hedge fund side, Pershing Square Capital Management, run by billionaire manager Bill Ackman, stands to become one of Valeant’s biggest losers. According to one estimate, Ackman’s has an average cost of $113.76 per share. Meanwhile, Valeant shares have been trading in the $26-$36 range.

Like Pershing Square, other hedge funds have become entangled in Valeant’s spiraling stock price.  

Hedge funds that held large stakes in the Canadian drug company at the end of last year include Braham Capital (25% of assets) and Valueact Capital (10.5%).

For financial advisors and investors alike, the similarities between Valeant’s rise and fall compared to its deceased predecessors is all too familiar.

Companies like Enron, MCI WorldCom, and Washington Mutual all had overly optimistic outlooks and engaged in  corporate shenanigans that briefly lifted stock prices before they collapsed. The hedge funds and mutual funds from that era also enjoyed the temporary benefits of concentrating their bets on these once-hot stocks but eventually suffered great losses.

What about today?

If Valeant is forced into bankruptcy, there will be more pain for large fund shareholders head. And it would most certainly reinforce the need for financial advisors to make sure the funds they buy on behalf of clients aren’t top-heavy with over-concentrated positions in just a handful of stocks.

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