According to FE Analytics, the Nasdaq OMX Biotechnology index has returned a mouth-watering 393.67 per cent over seven years, while the wider MSCI AC World index is up just 56.73 per cent over that time.
Performance of indices over 7yrs
Source: FE Analytics
Partly as a result of those strong historic returns, the AXA Framlington Biotech fund consistently has one of the most viewed factsheets on FE Trustnet.
Currently, the £641m fund sits third on the popularity list. Only FE Alpha Manager Mark Barnett’s Invesco Perpetual High Income fund and CF Woodford Equity Income, which is managed star manager Neil Woodford, have had more clicks over the last month.
It is understandable why AXA Framlington Biotech, which is managed by Linden Thomson, is such a favourite given its stellar returns over the years.
The fund is the best performer in the whole Investment Association universe over three, five and 10 year periods and is the only portfolio to feature in the list of top 10 performing IA funds in each of the last three calendar years – making 24.3 per cent in 2012, 63.65 per cent in 2013 and 45.5 per cent 2014.
While those returns are very eye-catching, when you drill down at the performance of the fund relative to its benchmark, it tells a slightly different story.
Our data shows the fund has underperformed against the Nasdaq OMX Biotechnology index over one, three, five and 10 years. While it has outperformed Pictet Biotech (the only other biotech fund with that long a track record) since Thomson took charge of the portfolio in July 2012, the fund has delivered an almost identical return to its benchmark over that time.
Performance of funds versus index since July 2012
Source: FE Analytics
Simon Callow, manager of the CF Seneca Diversified Growth fund, says one of the major reasons for the fund’s return profile over recent years is because of the fund’s AUM which – at £641m – is forcing the manager towards the index’s largest constituents meaning Thomson struggles to generate alpha.
Because of that and as the manager prefers backing young funds, Callow uses David Pinniger’s nimbler $35m Polar Capital Biotechnology fund for his exposure to the exciting asset class.
Callow believes biotech stocks can continue to outperform the market as certain companies are throwing off earnings growth of more than 20 to 30 per cent and rates Pinniger from his time as manager of the International Biotechnology Trust.
“We believe in David’s investment strategy and one of the positives is that he is starting with a clean sheet of paper,” Callow said. “The AXA Framlington fund is just too big and the manager probably has a lot of stocks she wishes she didn’t have, while David’s fund is full of his best ideas – there is no dead wood.”
Polar Capital Biotechnology is Callow’s seventh largest holding in his CF Seneca Diversified Growth fund.
Pinniger launched the fund in November 2013 and deliberately aims to build a different looking portfolio to the benchmark, buy splitting companies into different subsectors and moving up and down the market-cap spectrum, in an attempt to outperform.
Polar Capital Biotechnology has returned 95.56 per cent over that time, beating its Nasdaq OMX Biotechnology benchmark, the Pictect Biotech and AXA Framlington Biotech funds in the process.
Performance of funds versus index since October 2013
Source: FE Analytics
Pinniger says the fund’s size is very important to his investment style.
“When we launched the fund, we always said it was going to be a concentrated fund and that we would cap, or soft-close, it at around the $500m level as we don’t want it to be a big fund,” Pinniger said.
“As we want the fund to be concentrated, we realise we have to have good liquidity and gain access to small and mid-cap biotech companies. We want to be nimble as being able to get in and out of them easily will help drive performance.”
The fund is currently made up of just 40 stocks and while Pinniger holds 69.2 per cent in large-caps (biotech companies with a market cap of more than $5bn), he has 17 per cent in mid-caps and 13.8 per cent in small-caps.
The manager takes a relatively unique approach as he breaks the biotech sector into five screens, diversified earnings (which tend to be the large-caps), revenue growth, clinical development, technology platform and research tools diagnostics.
Again, Pinniger says size is vital to that strategy and while he doesn’t doubt the quality of active managers in the biotechnology sector, he says a fund’s AUM can be the biggest hindrance to future returns in the biotech space.
“You have to do something different to beat the benchmark because if you aren’t, investors might as well buy and ETF,” Pinniger said.
“As an active manager, you have to offer performance beyond that of the benchmark but to do that you have to build the portfolio in a different way and we think we do that by, due to our screens, allocating more to smaller companies.”
He added: “Bigger funds are challenged in that respect because they can’t get to those smaller companies and we don’t want that problem.”
However, while Pinniger says he would look to close the fund at $500m (or £335m), Thomson says that the size of her £641m AXA Framlington Biotech fund’s isn’t affecting her ability to manage the portfolio.
“I am comfortable managing the fund at its current AUM. We take a medium to long term investment view and liquidity is not determining where the fund currently invests or the size of investment,” Thomson said.
“However that said, we regularly have conversations with our risk team as to the liquidity and capacity constraints that all of our funds may have from time to time, as we closely monitor and review all of our funds at prescribed intervals.
“I continue to have the ability to buy small cap companies as that is often where much of the exciting innovation occurs - innovation or ‘meeting an unmet medical need’ is one of the main themes driving returns in my portfolio.”
While biotech, as a sector, has delivered superb returns over recent years certain industry experts have expressed concerns that it is turning into a bubble and therefore there is a growing likelihood of a correction.
Royce Associates’ Lauren Romeo recently told FE Trustnet that a material sell-off was looming as “desperate investors” are pumping up the rapidly growing biotechnology sector.
“Investment managers such as Fidelity and Wellington have started to invest in biotech. Part of it is investors are desperate for returns and are running out of places to look. That is always a sign that you are starting to near a mature part of the cycle – when non-traditional investors are coming into the space,” she said.
She added: "At some point it will come to an ugly ending, although I don’t know when it will be."
However, both Pinniger and Callow agree that the sector is performing so well because companies within it are generating huge amounts of earnings growth and are therefore deserving of their often higher P/E ratios.
“I’m not being flippant here, but we are not in a bubble,” Pinniger said last month.
“In terms of valuations and looking at big biotech versus pharma and the wider market, the P/E multiple this is only on a slight premium. 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.”
Polar Capital Biotechnology has an ongoing charges figure (OCF) of 1.35 per cent, which is more expensive than the AXA Framlington fund which has an OCF of 0.83 per cent.