This is a version of an article published in the Telegraph’s Questor column today.

Investment trust bargain hunter Nick Greenwood has recently bought a small stake in RTW Biotech Opportunities (RTW ) and investors who seek growth should consider doing the same as shares in small drug developers rally off extreme lows.

Greenwood, who runs the Migo Opportunities Trust (MIGO ) and specialises in buying listed funds when they are cheap and out of favour, said in the trust’s interim report last month that he had snapped up the dollar-denominated but London-listed RTW when the shares were at $1.10.

This left his fund with a stake worth £675,000 at the end of October. The position has since surged by 26.4%, thanks in part to a potentially lucrative plan for the £232m RTW to expand by an all-share takeover of rival Arix Bioscience (ARIX).

The deal, which still requires Arix shareholder approval, has proved controversial. Peel Hunt, a corporate broker for Arix, resigned in protest at the proposal for its biggest shareholder, Acacia Research of the US, to be bought out in cash, while other investors had to settle for 1.4663 RTW shares for every Arix share they owned.

While the City ponders the rights and wrongs of the transaction, the benefit to RTW from absorbing Arix, a previous favourite holding of former star fund manager Neil Woodford, looks enormous. For an outlay of $146m (£116m) it receives assets estimated to be worth $213m. Alongside the cut-price collection of listed and unlisted biotech stocks, it also gets $60m of cash that it can plough into new investments.

The prospect of that cheap financing has pushed RTW shares to a 21-month high of $1.39, which Greenwood said increased the likelihood that Arix investors would approve the merger in the coming weeks.

Still looking good value

Despite the rebound, RTW shares still do not look expensive; they are a long way off their $2.44 peak of nearly two years ago and trade at a 25% discount to the net asset value of $1.87, estimated by Morningstar, the investment analyst. The last monthly valuation published by the company put the NAV at $1.65 on 30 November.

Optimism that interest rates in Britain and America will be cut this year has also helped to repair some of the damage caused by last year’s surge in interest rates. Fears about the impact of high borrowing costs on speculative, early-stage companies crushed biotech stocks after the Covid pandemic boom to the extent that by last summer some smaller drugs companies were trading below the value of the cash they held.

Greenwood says the revival will not be short-lived and that RTW shares can recover to closer to NAV. His confidence comes from the sector’s success in launching new treatments as a record number of drug approvals fuels bids from major pharmaceutical companies.

‘Fifty per cent of new products are developed by smaller companies so the long-term winners are unlikely to be the big index stocks,’ he said. ‘A significant number of “blockbuster” drugs are coming off patent so big pharma has an urgent need and the necessary cash to buy biotechs in order to restock product lines.’

Getting in early

RTW, managed by a team of healthcare investment experts in New York led by founder Roderick Wong, likes to back biotech companies from the start. It invests in its core holdings when they are private but hangs on after they float on the stock market. Its biggest success since launch in 2019 came last April when US drugs giant Merck pounced on Prometheus Biosciences with a $10.8bn bid, attracted by its treatment for inflammatory bowel diseases such as Crohn’s.

RTW, which held nearly 15% of its assets in the company at the time and first invested $8.4m into Prometheus three years ago, received total proceeds of $99.1m. It has used some of this money to buy back its shares, enhancing shareholder returns.

RTW’s concentrated portfolio of 38 investments in the US, China and Europe is not for everyone, but Greenwood says that ‘counterintuitively the sector acts defensively heading into a recession’ because biotech shares tend to do well as US government bonds rise when interest rates fall in a downturn.

RTW is not the only horse the fund manager is backing, though. He has added RTW alongside bigger positions in Biotech Growth (BIOG ) and International Biotechnology Trust (IBT ) in his portfolio. Both are previous Questor tips that stand on discounts of 6% and 9% respectively.    

This column thinks investors should take a leaf out of Greenwood’s book and consider a small holding in a trust well positioned in a sector enjoying a strong cyclical recovery.