08:30 Mon 25 Jan 2010
James Burns: Why Biotech Growth Trust is the pick of the sector
Although we are currently enjoying a strong rally in the equity markets, 2010 is likely to prove to be a far tougher year in which to make reasonable investment returns.
When searching for ideas it is often worth looking at sectors that have underperformed for long periods and, as a result, have fallen off the radar screens of many investors. One such area that meets those criteria today would be the biotechnology sector.
There are several reasons to believe that the current environment offers a good entry point for investors into the asset class. Since US president Barack Obama unveiled his budget proposals in February last year the prospect of healthcare reform has served as an overhang on the healthcare sector generally, including biotech.
The actual risk to the biotech industry remains minimal, however, and fear would appear to be overly discounted into share prices.
The major, profitable biotech companies are now trading at historically low valuations and are as cheap as they have been since 1991. Virtually all generalist investors are underweight the sector so any change in sentiment could have dramatic impact.
Finally, mergers and acquisitions continue at a solid pace driven by 'big pharma' seeking to bolster its pipeline of drugs to greatly improve their growth prospects.
Many of these companies have very strong balance sheets and huge cash positions with which to make acquisitions at these bargain-basement levels and solve the problems they are facing.
A key driver of sentiment for the industry is new product breakthroughs and 2010 could prove to be a year that witnesses several biotech blockbuster drugs being introduced on the back of several key clinical trials.
Another factor that will help product development is that the Food and Drug Administration (FDA) regulatory environment in the US may be improving.
A new FDA commissioner, Margaret Hamburg, has been appointed and is expected to be far more proactive at approving drugs than her predecessor. As a Democratic pick, she is also far less likely to draw criticism from a Democratic Congress.
The FDA has historically been chronically understaffed, which has slowed the drug approval process but we expect the largest budgetary increase in FDA history to be announced for fiscal year 2010.In terms of ways to play this theme, I believe that the Biotech Growth Trust is as good as any.
Launched in 1997, it has been run by the highly regarded team at Orbimed Capital since 2005. There tends to be between 30 to 40 positions and the portfolio currently has a split of 40% in major biotech companies and 60% in smaller, emerging ones.
More than 90% of the assets are in the US with the remainder in Europe and the Far East.
Following a fund raising at the end of last year, the trust now has a market cap of £100 million and can gear its assets by a maximum of 10%. The discount tends to trade in a fairly narrow range as the board has a target to maintain it at a level no wider than 6%.
This is where the shares trade at the moment and so would seem an attractive entry level for new investors.
James Burns is head of investment trusts at Smith & Williams.
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