The Nasdaq Biotechnology index rolled over last month, raising fears that the sector, and perhaps by extension all tech sectors, were facing a crash in value after an exceptionally strong run. Martin says that while investors need to be careful about valuations on a stock-by-stock basis, the sectors have a number of strong winds behind them which should see them do well.
“The biotech sector has had a strong run,” he said. “But there’s an interesting behavioural thing for me in the UK for biotech companies.”
“A lot of people got burnt in the 2000 bubble and people in the UK have vowed to themselves they will never go back to those companies betting the farm on one drug.”
“People don’t want to buy biotech companies because they got burnt, but a lot of the particular mid cap biotech companies in the UK have a business model that has developed and become a lot more diversified, it’s more low risk.”
The Nasdaq Biotechnology index is down 11.28 per cent from its February peak, according to data from FE Analytics, having seen rapid growth over the preceding years.
Despite this stumble, the index is up 35.96 per cent over the past year as the FTSE All Share has made just 8.59 per cent.
Performance of indices over 1yr
Source: FE Analytics
However, the FTSE Pharmaceutical and Biotechnology index has been less affected by the loss of confidence in the sector.
Part of the reason is that there were some stock specific reasons for the US index’ fall: Gilead Sciences was served a warning letter from the FDA about its pricing structure.
However, another factor was the uneasiness about valuations on the sector which saw some UK closed-ended trusts trading on a discount even prior to the announcement despite huge NAV gains over the past few years.
What concerns investors is what happened during the early 2000s, Martin says, when the biotech sector was caught up in the dotcom boom and suffered big losses.
Performance of index Jan 2000 to Jan 2005
Source: FE Analytics
Martin says that valuations have risen to less worrying levels in the UK, partly because of fears this will happen again and partly because of other structural reasons.
“There’s an interesting divergence between the values of US biotech firms and UK,” he said. “UK biotech valuations for various reasons have always been significantly lower than they have been in the US for a number of reasons.”
“The US investor tends to be more risk-taking and more willing to buy early stage companies, so there’s valuation support reading across geographically to the US.”
Investors are particularly concerned about companies which have yet to bring their drugs to market. However, Martin says that UK investors have even been put off holding good stock such as Vectura and BTG which have recently managed to bring new drugs to market.
“Vectura and BTG have developed good diversified sources of profit making,” he said. “Vectura is on the cusp of making profits and BTG is making profits.”
Martin has sold BTG on valuation concerns and brought his weighting to healthcare and Biotech down to 17.37 per cent from 18.8 per cent at the start of the year.
However, he says he is awaiting a good price at which to buy in again and is convinced the healthcare and biotech story will be a major theme in years to come. He still owns Vectura.
For political and demographic reasons this remains a story with many years to run, he explains.
Performance of indices over 5yrs
Source: FE Analytics
“The US has consistently seen double digit price rises for drugs throughout the past few years,” he said.
“It’s very difficult for governments to say to drug manufacturers we aren’t going to pay you for your drugs.”
“The world needs to find more drugs – cancer in particular is a big issue.”
“There’s a huge amount of time and money and risk involved in developing new drugs. For me it would be a backward step politically and economically if governments were to reduce healthcare spending.”
Martin says that there is an extra dynamic in the developing world to this political issue: governments have to satisfy the growing demands of a larger and wealthier population.
“There’s an exciting story in places like China and the Middle East and they need to keep their populations happy, and one way is to provide security nets like healthcare.”
He also notes that the surge in M&A activity in the UK mid cap sector is likely to benefit healthcare and biotech companies in particular.
Martin’s £154m Neptune UK Mid Cap fund, which has five FE crowns and is in the FE Select 100, is the second best-performing in the IMAUK All Companies sector over three years with returns of 90.8 per cent.
However, its relative performance has slowed over the past year, during which the fund is second quartile.
This is thanks to the more defensive manner in which Martin runs the fund, focusing on valuations and as a result minimising volatility.
