Over recent months I’ve been gradually building my SIPP to have a thematic approach. After establishing a core using Invesco Perpetual Global Targeted Returns, CF Lindsell Train UK Equity and Artemis Global Income, I’ve been looking for a number of niche funds to sit alongside them and have finally made my decision.
Four such vehicles have been added to my SIPP but in this article we’ll concentrate on why two of them focus on the same part of the market – but why I don’t think this will be a problem and fits in with the overall aim of my portfolio.
In the previous article of this series, I looked at some of the major themes which it could be prudent to have exposure to over the coming decades. These included ageing populations, the spread of technology, sustainability and security.
When you drill down to it, most of the major themes – such as healthcare, energy and agriculture – are all driven by demographics. The West has to contend with a steadily ageing population while the emerging markets are seeing the rise of the middle class, both of which have massive implications for the global economy and stock markets.
Because of the west’s ageing population, healthcare seems like an obvious area of interest when viewed on a multi-decade horizon.
A recent report by Bank of America Merrill Lynch forecast the number of over-60s to increase from 841 million in 2013 to more than 2 billion by 2050. Some 65 per cent of all US healthcare spending is by the over-65s, for example, and this is only set to rise as higher life expectancies mean greater incidence of chronic diseases and degenerative illnesses.
To fit in with this theme I’ve taken a position in the Polar Capital Biotechnology fund, which is managed by David Pinniger and is relatively small at $40.9m.
Biotechnology has benefitted from a strong run over recent years, returning close to 300 per cent while global equities, as measured by the MSCI AC World index, gained less than 60 per cent. As the graph below shows, biotech’s run has come with some eye-watering corrections and we had a small sell-off just yesterday.
Performance of indices over 5yrs
Source: FE Analytics
Past performance is no guide to future returns and, to be honest, the recent strength of biotech does make part of me nervous. However, I think that the sector still presents a very compelling opportunity – although the returns might fail to keep pace with those we have already seen.
At the most basic level, biotechnology is technology that is based on biological systems. This is hardly new – bread and cheese making are primitive forms of the technology that have been around for thousands of years.
Modern biotechnology is aiming to combat debilitating diseases, reduce environmental damage, enhance food product, develop cleaner energy and create more efficient industrial manufacturing processes.
It’s the healthcare angle that I find most interesting and the area that most biotech funds focus on. Biotech companies are working on therapies for a wide range of illnesses, including cancer, cardiovascular disease, chronic liver disease and rare genetic disorders, and are seen as developing the ‘medicines of tomorrow’.
Meanwhile, the technology is bringing into reach the prospect of so-called personalised medicine – or treatments that can be tailored to each individual. This is something I hear a lot of positive news about from my girlfriend, who works in the medical research field, and is also on radars of investors such as Neil Woodford.
But think about biotechnology investing and the word ‘bubble’ springs to mind, following the sector’s strong run. However, in a recent presentation to one of my colleagues, Pinniger highlighted why he does not believe this is the case.
According to Polar Capital’s figures, the median biotech stock is trading on a 12-month forward price-to-earnings (P/E) ratio of little under 20 times. This is around the same as the US pharmaceutical sector’s median P/E and only slightly higher than the S&P 500’s.
It’s also in stark contrast to the P/E’s of more than 115 times during 1999 and is lower than 30 times earnings that were seen in 2013.
This helped to allay my concerns about biotech’s valuations but why did I choose the Polar Capital Biotechnology fund for exposure to the sector?
Pinniger has more than 12 years of investment experience in the healthcare sector and the portfolio’s team of four sector specialists has more than 60 years of combined industry experience. It also focus on smaller companies, where the real growth of the industry seems to be.
The fund’s 108.36 per cent return since launch in October 2013 is 20 percentage points higher than the NASDAQ Biotechnology index’s rise. This has come with slightly more volatility and a higher maximum drawdown, but given my SIPP is a long-term portfolio I’m comfortable with that.
Performance of fund vs index since launch
Source: FE Analytics
While researching which funds to add to my SIPP another which caught my eye, and I have bought, is Michael Sjostrom and Stephan Patten's $850.9m Pictet Generics fund.
I’m generally wary of traditional ‘big pharma’ companies given the challenges that face their business models, but this fund gives exposure to an area of the healthcare industry that is profiting from one of these headwinds – the sale of generic versions of blockbuster drugs.
A generic drug is identical to a brand name drug in dosage form, safety, strength, route of administration, quality, performance characteristics and intended use. The key difference is that they are usually sold at a significant discount to the branded drug.
This means that when branded drugs come off patent and generics can be produced, the cost savings prove especially attractive to consumers such as hospitals and emerging markets. This causes an obvious hit to the profits of the big pharma firms that first developed the drug but creates a steady market for firms specialising in generics.
Pictet Generics, which holds four FE Crowns, is benchmarked against the MSCI World and has outperformed global equities over three and five years with respective returns of 113.46 per cent and 104.11 per cent.
Performance of fund vs index over manager tenure
Source: FE Analytics
This fund is playing the opposite end of the industry to Polar Capital Biotechnology. While biotechnology is concerned with cutting-edge research and developing the next wave of innovative medicines, generics is more about expanding the availability of healthcare beyond the west.
Therefore, it’s also a play on the expanding middle class of emerging market. For example, Pictet Generics has 28.3 per cent of its portfolio in the US but 15.7 per cent in India, 7.5 per cent in China, 7.3 per cent in South Africa and 2.8 per cent in South Korea.
Of course, buying the fund at the same time as the biotech one might raise the concern that I have doubled up on pharmaceuticals and would take a significant hit should investor sentiment towards the sector reverse.
However, FE Analytics shows that the funds have a low correlation with each other, amounting to just 0.60 since the launch of Polar Capital Biotechnology. So these two funds don’t have their fortunes tied together.
What’s more, the Polar Capital fund has an even lower correlation to the wider pharmaceutical industry, coming in at 0.28 for the MSCI World Pharmaceuticals index; Pictet Generics’ is higher at 0.81.
As these aren’t the only thematic funds I’ve just bought for my SIPP, I’m happy to have two that focus on the same area of market as my other holdings look at different themes. Plus, I don’t think of them as being ‘pharmaceutical plays’ – one is exposure to innovation and ageing populations while the other to emerging market growth and a disruptive trend.
In a coming article I’ll put the remaining two funds under the spotlight and explain why I like sustainability and security.