The biotech sector had a great run through 2012 and 2013 but since the end of February, some of the froth has come off the sector. I have been wondering whether this might present a buying opportunity?
The arguments in favour of biotech still stack up. They include a growing, ageing and wealthier population creating demand for new drugs and the fact it’s often easier for big pharma to buy into or partner with biotech companies than develop drugs themselves.
If you think about it, it is a bit odd that the sector has a habit of swinging in and out of favour with investors since the rate of discovery of new drugs is uncorrelated with market moves and demand for new therapies is fairly price inelastic.
Nevertheless investors have a tendency to both neglect the sector and then get wildly over-enthusiastic about it.
I thought this week I’d look at International Biotech Trust (IBT).
IBT has been around since 1994 and has seen its fair share of these sentiment swings, most dramatically in the tech boom. The fund’s share price almost quintupled over the year ended 31 August 2000 and then collapsed just as fast.
For IBT, the turmoil was exacerbated as it came under attack from an arbitrageur. This coincided with the appointment of Schroder Ventures Life Sciences Advisers (UK), now SV Life Sciences, as the investment adviser to the fund (it took up the reins in November 2000).
The fallout from the collapse of the tech bubble continued until autumn 2002. IBT’s share price got down to 50p but, over the next nine years, it clawed its way back to close triple that.
In autumn 2011, the latest bull phase for biotech stocks began and IBT’s share price more than doubled, hitting a high of 332p before retrenching to the current level of 292p.
But for two factors, the recent share price performance could have been even better.
The first of these is IBT’s discount, which is currently close to 19%. The board regularly renews the company’s buy-back powers and does use them. It has bought back 825,000 shares over the past 12 months – more than in the previous two years combined.
This has not stopped IBT’s discount swinging between just under 2% and over 26% over the past year.
Boards will often say they hope their fund’s discount will narrow on the back of better performance, IBT’s board said as much in 2010, so it may give them pause for thought that IBT’s discount was stubbornly wide in January and February this year before prices of biotech stocks cracked. (However, this could be an example of discounts in the investment trust sector acting as a leading indicator of future market moves).
The other factor that has had an adverse impact on IBT’s performance is its exposure to unquoted investments.
Funds with unquoted investments often trade on wider discounts because of the illiquidity of their portfolios. Unquoteds were 8% of the fund at the end of June 2014.
These investments do not get revalued that often and so it is natural the net asset value (NAV) of a fund holding a proportion of its assets in unquoteds will lag the market.
The quid pro quo for this should be that the occasional exit from an unquoted holding will deliver a sizeable boost. Over the past few years though, the unquoted holdings have been a sizeable drag on performance.
At the end of February, IBT held 19 unquoted investments the largest of which was Aptiv Solutions, a medical research services company. This got sold at the end of March.
Affinium sold its business to Debiopharm in February 2014 and another holding, Ophthotech, listed on Nasdaq in September 2013. All of these fetched a premium to IBT’s carrying value but none was especially significant for the NAV.
If we strip out the unquoteds and just look at the performance of the quoted holdings versus the Nasdaq Biotech Index, IBT’s portfolio kept pace with the index over the six months to the end of February 2014, lagged by some margin over the year to the end of August 2013, outperformed by 2.5% over the year before that (almost making up for underperformance in the year to end August 2011) and underperformed the year before that.
The valid excuse for failing to consistently outperform the index is that not holding the ‘right’ stocks can leave you trailing the index by miles. The nature of the industry is that getting a drug to market can have a transformative impact on a company.
Win some, lose some
By the same token, many drugs fall at the final hurdle. IBT cannot hold everything so maybe it is inevitable that it will miss the odd blockbuster.
It might not be fair to look at the long-term performance numbers, however. In September 2013, SV Life Sciences brought in new manager Carl Harald Janson for the quoted portfolio. He is supported by Ailsa Craig, who has been working as an investment manager on the fund since 2008.
Janson has a great track record, established while managing the Carnegie Biotechnology fund, and was recognised by Bloomberg as the top performing biotech manager in the world, outperforming the Nasdaq Biotech Index by 80%. Shareholders will be hoping he can replicate this at IBT.
James Carthew is a director at Marten & Co