We take a look at the unloved biotechnology space and the investment trusts which specialise in this area
Thursday 28 Nov 2019 Author: Martin Gamble

The biotechnology sector has been in the doldrums relatively speaking over the last five years having under-performed the FTSE World index by 48% and the MSCI World HealthCare index by 39%.

According to Bloomberg data the sector is trading on a one-year forward price-to-earnings (PE) multiple of just 9.9 times, the lowest in 25 years.

We have delved into the issues that have been driving performance and compare investment styles across the sector, in an effort to unearth a bargain investment trust in this space. Our favourite is the Worldwide Healthcare Trust (WWH).

GROWTH DRIVERS UNDERMINED BY REGULATORY PRESSURE

Historically the Nasdaq Biotech index has outperformed the wider market, delivering an average annualised return of 10.5% per year over the last 20 years, compared with 6.3% per year for the MSCI World Healthcare index and 5% per year for the MSCI World index.

Data from the United Nations shows that there will be 2.1bn ‘elderly’ people by 2050 as the percentage of the over 60s increases from 12.5% to 22%. This trend will result in increasing demand for healthcare. Drug companies will meet that demand by producing more drugs that prolong people’s lives and allows them to live better in old age.

Drug pricing has been and remains a key battle ground in US politics as the 2020 elections come into view. The key concern is that Bernie Sanders’ proposal of ‘Medicare-for-all’ would hit profitability of the industry hard.

However the problem is the multitude of industry ‘intermediaries’ that take 41% of total healthcare spending while drug manufacturers only account for 10%.

Despite the political fog, the regulatory backdrop is supportive with a record number of Federal Drug Administration (FDA) approvals last year to 59 compared with just 25 a decade earlier.

THE ADVANTAGE OF USING FUNDS TO GET EXPOSURE

Few investors are sufficiently armed with the specialist knowledge needed to find tomorrow’s winners in the sector. All of the trusts in the sector employ PhDs as well as statistical experts in the design of drug trials which gives them a clear edge.

In addition, developing new drugs at the limits of science is a very risky and expensive business, so it makes sense to hold a diversified spread of investments through a fund or trust.

As we will see, some trust managers are more diversified than others, so it pays to know how they compare.

Life science trust, Syncona (SYNC) focuses on investing in and building global leaders in life science by taking controlling stakes in early stage companies. Seven out of eight companies in the fund were founded by Syncona.

The trust’s record for creating commercial therapies is excellent, so much so that it might be argued that the company is a victim of its own success.

Following recent successful portfolio sales, (Blue Earth represented a 10-fold return and Nightstar a 4.5 times return) and net proceeds of £592.6m the trust has a huge unused capital base of £855m, which is 64% of the total assets.

Although the current 13.4% premium to net asset value (NAV) is much lower than the 54.5% peak, the trust trades at the largest premium in the sector reflecting past successes. The company has a ‘rich pipeline’ of new opportunities, but it isn’t obvious why investors should continue to pay a premium for a fund which is almost two-thirds  in cash.

OUR FAVOURITE PLAY

Our favourite play is Worldwide Healthcare Trust which is on a 3.5% discount to NAV, close to historic lows. It has among the best five-year performance in the sector, and therefore current levels look anomalous and potentially good value.

Managers Sven Borho and Trevor Polischuck, partners at Orbimed, see many opportunities in what they call the ‘golden era’ of innovation. They highlight gene therapy, where Sarepta Therapeutics is developing a treatment for muscular dystrophy. Another area is cell therapy for the treatment of lymphoma.

Orbimed also advises on the Biotech Growth Trust (BIOG) which is co-managed by Geoff Hsu. It is smaller than WWH and focused on the narrower biotech universe. The team runs a concentrated portfolio of 30 to 45 names and they look to identify catalysts in emerging biotech companies.

Relatively poor recent performance means that the trust sits on a 9% discount to NAV.

International Biotechnology Trust (IBT) has been managed by SV Health Managers since 2001, and is one of the world’s leading life science investors.

In contrast to the Biotech Growth Trust, the IBT managers try as much as possible to mitigate the volatility and risks associated with drug trials. Rather than trying to figure out if a drug might get approved, the team actively reduce their exposure ahead of known ‘event risks’.

RETREATING FROM BIOTECH

BB Healthcare (BBH) is a high conviction fund of 35 stocks, unconstrained by the benchmark, run by Paul Major and Brett Darke of Bellevue Asset Management. The pair has radically reduced exposure to biotech over the last year and it only represents around 10% of the portfolio.

Today the fund is mainly exposed to managed care, medtech and diagnostics companies which represent 45% of the fund.

The Polar Capital Global Healthcare Trust (PCGH) trades at the biggest discount to NAV in the sector (10.3%). This despite the fact it has performed in line with IBT, which trades close to NAV.

The fund’s largest exposure is to healthcare equipment companies which represent 37% of the portfolio, while large listed pharmaceutical firms make up around 27%. Similar to BBH, the team has a relatively small exposure to biotech, around 14% of the fund.

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