Worldwide Healthcare (WWH ) has become the latest casualty of the sector slump as record underperformance in emerging biotech and out-of-favour small-caps unravel its record results.

Biotech and healthcare stocks are in the midst of an extended bear market which has taken its toll on the £2bn investment trust run by Sven Borho and Trevor Polischuk at New York-based Orbimed.

In the year to the end of March, the closed-end fund’s net asset value total return fell 5.8%, a sharp downturn from the 30% increase it racked up in the previous year – one of the best years on record. The shares slipped even further as investors lost faith, dropping 10.8% over the period, and significantly underperforming the MSCI World Healthcare benchmark, which was up 20.4%.

Although the decline has slowed since the financial year-end, the shares have fallen 17% in the past year, leaving them on a slightly wider than normal discount of 5% below net asset value.

This has depressed three-year returns to 33%, less than half the 73% from the MSCI World Health Care index. Over 10 years, however, shareholders have received 342% including dividends, ahead of the benchmark’s 327%. 

Borho said the downturn was fuelled by macro factors that left ‘sector and company fundamentals firmly taking a backseat and going largely unrecognised by investors’. The switch from growth to value stocks also hurt as investors favoured large companies over smaller businesses. Like sister trust Biotech Growth (BIOG ), an overweight in emerging biotech, Chinese healthcare and innovative tools ‘materially underperformed’.

‘This was exacerbated by our long-term underweight positioning in pharmaceuticals – typically all large-cap stocks – a sector that outperformed the rest of healthcare,’ he said.

However, Borho said the fundamentals for the sector remained strong, especially in biotech, and the macro factors do not represent ‘a deterioration of the elements that underpin the sector’.

‘Rather, it is simply a product of extreme market conditions that we have never experienced previously, culminating in a profound collapse in valuations, a situation that should reverse in due time,’ he said.

The biggest detractors from performance included Mirati Therapeutics, an emerging biotech firm focused on developing therapeutics for the treatment of cancer. Although it achieved milestones for its drug Adagrasib, which targets solid cancerous tumours, including a successful new drug application with the US Food and Drug Administration (FDA), the share price was ‘punished’ after multiple management changes and a share issue.

‘Most recently, the stock was under pressure again after the FDA accepted the filing for Adagrasib but granted a regular review rather than the expected priority review, pushing the potential approval and launch in 2023,’ said Borho.

Unusually, the managers also took a brief position in the SPDR S&P Biotech exchange traded fund (ETF), which tracks the S&P Biotechnology index. 

Borho said he took out the position to ‘gain exposure to a tactical rebound as we went through the year’ but ‘unfortunately, our purchase was premature, and the [ETF] continued to sell off right into the financial year end’.

Borho and Polischuk also made four new investments into unquoted companies - one of which completed an initial public offering (IPO) – and now make up 7% of the portfolio. While the managers do not give specific details of the companies, they are ‘all healthcare companies in emerging markets – one in India and three in China’.

The unlisted holdings contributed gains of £21.8m to the portfolio, equivalent to a return of 15%, over the year.

‘In the US, a challenging public offering market for small and mid-cap therapeutics companies made pre-IPO crossover investments unattractive in the year,’ said Borho.

While healthcare continues to be a challenging sector, Borho said innovation continues and a new commissioner at the FDA – which had been accused of being ‘rudderless’ – is ‘industry-friendly’.

US president Joe Biden is considered less industry-friendly and the sector is still being overshadowed by the ‘dark cloud’ of prescription drug reform. However, Borho said with the war in Ukraine, political attentions are turned elsewhere and ‘we believe that expectations for any drug price reform have now appropriately faded’.

Following Pfizer’s $11.6bn cash purchase of Biohaven Pharmaceutical last month, Borho looked forward to an acceleration in mergers and acquisitions that have buoyed share prices in the sector in the past.

Borho said M&A had always been a ‘notable source’ of returns and the last two quarters had seen what he called ‘profound messaging’ from large pharmaceutical groups that they were setting inorganic growth as a top priority.

‘Overall, this may be a harbinger of things to come and could be a real rallying point, especially in the biotechnology sector,’ he said.