A Changed
Biotech Sector Draws Fans
Barron's
July 15, 2013
The past few years have been good for drug research -- and for investors in the health-care/biotechnology sector.
Thanks largely to advances in genetic analysis that have led to the development of breakthrough drugs, the Nasdaq Biotechnology Index has shot up 69% over the past two years."It's an exciting time for the biotech sector," says Andrew Acker, manager of the Janus Global Life Sciences fund (ticker: JNGLX), who notes that regulators approved 39 drugs in 2012, the most in 16 years. Investors seem to agree, having poured $5 billion into the sector this year.
Health-care/biotech stocks are typically seen as defensive, a destination for when the economy is hurting. But as the recovery marches along, the sector shows no signs of slowing. Indeed, through July 10, the biotech index had climbed 35% this year, versus 16% for the S&P 500. Health-care/biotech has outperformed all other sectors this year, reports Lipper.
And while the recent market pullback has trimmed valuations, fund managers remain enthusiastic about the group, thanks to a strong roster of drugs and therapies under development. "I'm optimistic," says Evan McCulloch, manager of the Franklin Biotechnology Discovery fund (FBDIX). "I look at the pipeline as the strongest it's ever been."
Still, many fund managers and sector watchers foresee a substantial head wind in the form of health-care economics. "The biggest question for biotech and health care in general is how our society is going to be able to afford to pay for medicines," says Rajiv Kaul, who manages the Fidelity Select Biotechnology fund (FBIOX).
The sector's recent success is largely rooted in advances in genetic research. By analyzing the genetic information behind specific kinds of cancer and other diseases, companies are gaining the ability to develop more effective medications that can be matched to patients.
Example: Xalkori, a Pfizer (PFE) drug that was approved in the U.S. in 2011, has significantly extended the lives of lung-cancer sufferers with a specific genetic mutation. Likewise, Zelboraf, developed by Roche Holding (RHHBY) and Daiichi Sankyo (4568.Japan), has proved successful in fighting the deadliest form of skin cancer.
Promising drugs are in the pipeline to treat everything from pancreatic cancer to cystic fibrosis. Six of the seven largest biotech companies are going through major product launches now or are expected to do so shortly, says Acker.
The biotechnology field encompasses everything from creating genetically modified food to using micro-organisms to clean up oil spills and other messes. But for investors, health care is quite simply where the action is, says Acker, whose fund is 94.39% composed of health-care stocks.
Although many biotech portfolio chiefs favorgiants like Amgen (AMGN) or Gilead Sciences (GILD), they use different strategies. Janus Global Life Sciences hedges its bets on biotech with everything from conventional pharmaceutical companies to health insurers; among its top holdings are Aetna (AET) and Express Scripts (ESRX).
Funds also differ in the extent to which they bet on smaller companies. Franklin Biotech Discovery invests as much as 30% of its assets in stocks with a market value under $2 billion. Currently, 26% of its holdings are small- or micro-caps, versus 15%, on average, for its peers, according to Morningstar. Says McCulloch: Small firms are "where a lot of the really exciting science and product development is occurring right now."
His current favorite is Celldex Therapeutics (CLDX), which accounts for 1.9% of his fund's assets. Celldex makes compounds for two kinds of cancer. Its products fulfill highly unmet needs and have little competition, which means the company might be able to successfully "navigate the new payer landscape," maintains McCulloch, referring to the expected squeeze on biotech companies as health-care economics change.
"Pricing pressure has been a huge issue in Europe because of budget problems and austerity measures," says Morningstar analyst Karen Andersen, adding that the same issue lies ahead for the U.S. Eventually, she predicts, pressure from government insurance programs and managed-care companies will end big price increases.
Another looming obstacle for biotechs is the threat of competition from "biosimilars" -- essentially generic versions of a class of drugs known as biologics. Biosimilars have trimmed the sales of biologics makers in Europe, and they're expected to gain entry to the U.S. within a few years.
Head winds aside, McCulloch sees health-care/biotech as a sector that's evolved into a dependable producer of successful products. "Investors still think of it as it was 10 or 15 years ago, a collection of small companies that lose investors' money," without introducing viable products. "But for the past 10 years, there have been 30 to 40 drugs approved per year," he notes.
Fidelity's Kaul, however, warns that "a boom-and-bust situation has been the historical characteristic of the industry. The question is how sustainable this [rally] can be."
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Scoreboard: Stellar Week
Actively-managed U.S. stock funds posted a 3.57% gain in the week through Thursday, bringing their year-to-date increase to 17.82%. The weekly and 2013 gains have lagged the market, however. Beleaguered bond funds stabilized with a 0.09% rise through Thursday.
One Week Year-to-Date
U.S. STOCK FUNDS 3.57% 17.82%
U.S. BOND FUNDS 0.09 -1.18
TOP SECTOR / Equity Leverage Funds 7.34 24.60
BOTTOM SECTOR / Dedicated Short Bias Funds -6.24 -17.34
THE WEEK'S TOP 10
Fund
Investment Objective One Week Year-to-Date
Direxion China Bull 3X
DL 18.46% -3.84%
Direxion M Chn Bl 2x Inv
DL 15.70 -27.06
ProShares Ult FTSE Ch 25
DL 15.57 -26.08
Direxion S Korea Bull 3X
DL 15.36 NA
VelShs DlyInv VIX ST ETN
DSB 15.25 41.89
ProShs II ShVIX STF ETF
DSB 15.16 41.26
Direxion Russia Bull 3x
DL 14.25 -37.51
Direxion EmgMk Bull 3X
DL 14.24 -31.86
Direxion DevMk Bull 3X
DL 14.17 20.42
Direxion BasicMt Bull 3X
DL 13.96 20.81
THE WEEK'S BOTTOM 10
Fund
Investment Objective One Week Year-to-Date
ProShs II UltVIX STF ETF
Specialty & Misc -26.21% -75.49%
VelShs Dly 2x VIX ST ETN
Specialty & Misc -26.14 -75.78
VelShs Dly 2x VIX MT ETN
Specialty & Misc -17.66 -48.47
Direxion China Bear 3X
DSB -16.88 -16.91
Direxion S Korea Bear 3X
DSB -15.99 NA
Direxion EmgMk Bear 3X
DSB -14.78 21.75
Direxion Russia Bear 3x
DSB -14.72 20.87
ProShares UlS FTSE Ch 25
DSB -14.64 20.36
ProShs II VIX ST Fut ETF
Specialty & Misc -13.86 -44.67
Direxion Gold M Bear 3X
DSB -13.84 236.34
THE LARGEST 10
Fund
Net Assets 3-Year* 1-Week YTD
(billions) Investment Objective Return Return Return
PIMCO Tot Rtn Inst
$167.421 Intmd Inv Grade 4.66% -0.04% -3.03%
SPDR S&P 500 ETF
133.000 S&P 500 Funds 18.44 3.73 18.71
Vanguard T StMk Idx Inv
91.753 Multi Cap Core 18.84 3.77 19.18
Vanguard Instl Indx Inst
77.610 S&P 500 Funds 18.55 3.74 18.78
Vanguard T StMk Idx Adm
71.451 Multi Cap Core 18.99 3.77 19.25
Vanguard 500 Index Adm
69.284 S&P 500 Funds 18.54 3.74 18.77
Fidelity Contrafund
63.993 Large Cap Growth 17.32 3.55 16.65
American Funds Inc A
61.961 MTAM 13.78 2.83 10.41
American Funds CIB A
60.904 MTAG 11.56 2.94 8.16
American Funds Gro A
60.766 Large Cap Growth 16.39 3.67 16.89
*Annualized. Through Thursday.