The performance of biotech funds, which invest in companies that use living systems and organisms to develop drugs and other products, over recent years has been outstanding as the average portfolio in the space has returned 231.64 per cent over five years and 112.07 per cent over two years.
As a point of comparison, the MSCI AC World index is up 68 per cent and 26 per cent over those two time frames.
Performance of composite portfolio versus index over 5yrs
Source: FE Analytics
Those returns haven’t just been down to one or two good years either. Our data shows AXA Framlington Biotech – which is the only biotechnology fund in the onshore universe – is the only portfolio to be among the top 10 performing IA funds, out of a possible 3,436, in each of the last three calendar years.
There is also evidence to suggest that more and more investors are taking an interest in the sector as AXA Framlington Biotech is one of the most read factsheets on FE Trustnet, along with industry stalwarts like CF Woodford Equity Income and Invesco Perpetual High Income.
Given that biotech funds have performed so strongly over such a short period of time and investor interest is soaring, a number of experts have warned that a bubble is forming in the sector. However, Pinniger – manager of the Polar Capital Biotechnology fund – says that simply isn’t the case.
“I’m not being flippant here, but we are not in a bubble,” Pinniger said.
“You’ve had this woosh, so people look at the returns and think, ‘yikes this is crazy and clearly a bubble’. The difference this time is that it is being driven by real products which are generating phenomenal amounts of cash.”
“If you go back to 1999/2000, the performance of the industry was basically coming from enthusiasm and exuberance about the promise of what it could deliver at some point in the future. What’s going on now, 15 years on from that period, is all of this phenomenal amount of capital is actually being invested which is beginning generate products which are driving revenues and cash flow.”
During the TMT bubble of the late 1990s, it was commonplace to see exciting new biotech companies trading on huge multiples. The P/E ratio on the Nasdaq Biotechnology index was close to 60 times at the height of the rally, for example.
However, Pinniger says there are some major differences this time around.
He points out that the earnings growth of leading companies in the sector has been very good. He also says that biotech companies are not even that expensive either – the index is on a multiple of around 20 times – despite the recent strong returns.
“In terms of valuations and looking at big biotechs versus pharma and the wider market, the P/E multiple this is only on a slight premium,” Pinniger explained.
“If you look one or two years ahead, biotech is at a discount. The fact that we are not seeing multiples of 40, 50 or 60 times tells me that it is based on a rational assessment of the earnings growth these companies have delivered and are set to deliver over the coming years.”
He says that in the small-cap space, it is a slightly different story, as some biotech companies are very expensive for the growth they are likely to offer – though he points out that is the case in most industries.
Pinniger isn’t overly concerned, however. The major reason for that is due to his own research which shows that the average biotech IPO since January 2013 has underperformed the wider Nasdaq Biotechnology index since it came to market, which Pinniger says is further evidence that the market isn’t getting carried away with itself.
His thoughts are echoed by Charles Stanley Direct’s Rob Morgan, who recently told FE Trustnet that investors can afford to keep buying biotech funds despite their higher valuations as it is one area of the world which offers genuine growth.
That’s not to say Pinniger is getting carried away, however.
He says the major concern that keeps him up at night is if the wider market were to “fall out of bed” as biotech companies, given their higher risk nature, are likely to be hit the hardest in a full blown-sell-off.
A number of experts have predicted such an event in the not too-distant-future, given economic headwinds in China, the end of the QE experiment, extremely low bond yields and the prospect of higher interest rates in the US.
While Pinniger is aware of these dangers, he says there are positives for investors in biotech.
“As the broader market has trended upwards, macro headwinds have seemingly whipped into a massive storm and so are more risky asset classes, like biotech, going to get hit first?” he asks.
“Yes, biotech is high beta sector so it is going to get walloped. However, what happened last year – which I think is interesting – is that each time there was a market-driven correction, biotech bounced back incredibly hard. The reason for that? It has been fundamentals driving it.”
In last year’s volatile market – when investors rotated away from high multiple growth stocks into ‘safer’ large-caps – the MSCI AC World Biotechnology index was twice as volatile and had a maximum drawdown three times greater than that of the MSCI AC World index.
Performance of indices in 2014
Source: FE Analytics
However, as the graph above shows, the biotech index still considerably outperformed last year.
Pinniger added: “I’m not worried about a bubble or paying up [for biotech companies], what worries me is whether the wider market is going to fall out of bed.”
Prior to joining Polar Capital, Pinniger managed the International Biotech Investment Trust and had worked within the sector for a venture capital firm and at Morgan Stanley. He launched the $30m Polar Capital Biotechnology fund, which sits in the offshore universe, in October 2013 and it has comfortably outperformed since.
According to FE Analytics, the fund is up 71 per cent over that time, beating the average biotech fund by 10 percentage points and its Nasdaq Biotechnology benchmark by 13 percentage points.
Performance of fund versus composite portfolio and index since Oct 2013
Source: FE Analytics
It is a concentrated portfolio of just 40 holdings and has more of a small-cap bias than most of its competitors. In an article next week, we will compare and contrast the fund with the more well-known – and ever popular – AXA Framlington Biotech fund.
Polar Capital Biotechnology has an ongoing charges figure (OCF) of 1.35 per cent.