A correction in rallying stock markets often produces a lot of head scratching for investors: should you buy or sell?
This is extremely pertinent in the one of the most popular markets with our readers. Biotechnology has consistently been the best place to invest over the past five years or so, and is also top of the tables over the past decade.
The likes of AXA Framlington Biotech and Candriam Equities Biotechnology funds have produced sky-high returns that top the tables in the 3000-plus strong Investment Association universe – having made annual returns of more than 15 per cent in each of the past three years
Source: FE Analytics
On top of that, biotechnology funds (possibly due to their very high returns) often have the most read factsheets on the FE Trustnet website.
However, the rally has had its hardest correction in the past three months, with the NASDAQ Biotech index down more than 22 per cent. The falls coincided with two important events: a general risk off period from investors that culminated in heavy selling during August’s Black Monday, as Russ Koesterich, BlackRock’s global chief investment strategist notes.
Performance of biotech funds and index since sell off
Source: FE Analytics
“With investor risk aversion climbing, so-called high-beta, momentum names that are more volatile continue to suffer,” Koesterich said.
“For example, at the lows last week, the Nasdaq Biotech Index was down nearly 30 per cent from its July high. Moreover, the returns derived from merger-and-acquisition deals have been falling recently.”
More importantly, though, were comments from prospective democratic presidential candidate Hilary Clinton that she would seek to put greater controls on the price of pharmaceuticals after the price of niche cancer and Aids drug was ramped up 5,000 per cent overnight by a an activist investor.
Mirjam Heeb, investment manager for GAM's health innovation strategy, says biotech and specialty pharma stocks have been hit by news flow regarding US drug pricing, particularly Clinton’s proposal to focus on drug costs, providing a huge opportunity for bargain hunting investors.
“We believe the concerns around pricing have been overblown. Pricing pressure in the US has been discussed for the last 20 years, yet prices have increased by 3-5 per cent per unit dispensed every year for as long as we can remember. Drug costs account for only 10 per cent of overall US healthcare spend and it is a small contributor to the overall problem of escalating healthcare budgets.”
“While average price increases have been above average this year, they have not been exorbitant and are unlikely to be sustained. The pricing expectations in financial models are in line with long-term trends. Any impactful pricing headwinds would require a major pricing reform passed by the Congress which could prove to be very difficult, especially given the Republican dominated situation.”
She says a high level of innovation will protect against pricing pressures due to an unyielding demand for better quality treatments
“We focus on companies with highly innovative products such as Celgene, Gilead and Roche because we believe they will be best positioned to defend prices over time. We also focus on specialty pharmaceutical companies such as Allergan and Galenica as they are also benefitting from structural drivers such as M&A to unleash value.”
“The correction provides highly attractive opportunities to add to positions and to invest in new companies on a bottom-up stock specific basis. For example, many immuno-oncology stocks we felt were fairly valued in the first half of the year now offer good value.”
However, she says the year ahead could provide further pressure on prices from the political arena.
“With the US election year ahead the pricing issue could continue to put pressure on the sector short-term, but we are excited about the long-awaited buying opportunity and outlook for the next 12 months.”
“Products continue to advance at an unprecedented pace and we expect a lot of positive news flow going into the end of the year and in early 2016. This coupled with an M&A dynamic that is set to continue, even if somewhat abated, provides for many interesting investment opportunities.”
AXA Framlington Biotechnology has been one of the best performers of the past five years. Its manager Linden Thomson, who has headed the fund since 2011, was not surprised to see the recent correction, having built up cash and moved into the more defensive larger cap parts of the market in recent months.
Performance of fund versus index under Thomson
Source: FE Analytics
However, she says she is now buying into small and mid- caps stocks as these have now hit attractive entry points.
“It did not surprise us to see the exaggerated sell-off in biotechnology catalysed by profit-taking by investors and concerns about global, and in particular, Chinese growth.
”Importantly, aside from risk appetite more broadly, there is limited contagion from China to the biotechnology sector.”