How investing in biotechnology can provide capital growth and income
31 October 2018
Some investment rules are considered immutable. For example, an asset can either deliver high growth or provide high income. But that’s not always the case – it is possible to receive both.
A standard open-ended income fund will typically select companies which provide high dividends, such as utility stocks. These tend to be low growth stocks so returns are skewed towards income and away from capital appreciation.
At first glance, it seems impossible that a biotechnology investment could be a source of income. This sector has performed well over the last decade delivering considerable compensation for growth investors. But these returns have been skewed towards capital growth as most companies pay no or low dividends.
The International Biotechnology Trust (LSE:IBT) offers a solution to the income versus growth conundrum by using capital reserves from accumulated profits to top up dividend payments. In essence, it converts part of the capital growth of the biotech sector into dividend income for investors. International Biotechnology Trust currently offers a yield of 4%.
The Lead Investment Manager, Carl Harald Janson said, “We are confident International Biotechnology Trust can maintain this level of dividend payment. Over the last 20 years, the NASDAQ biotechnology index has appreciated by 12% a year. Even paying out 4% of this growth as a dividend leaves 8% capital growth for the investor.”
There are good reasons to feel confident about future growth prospects. Changing demographics are increasing the need for medicines. Populations are ageing in the developed world while the middle class in the emerging markets is growing.
Both of these trends will drive demand for drugs. Companies will be able to meet this need as their ability to innovate has become more effective and the regulatory approval process has become easier to navigate.
This should translate into a continued double-digit appreciation of the sector over the next decade which will provide an ample margin for International Biotechnology Trust to maintain its target 4% dividend.
But while the Trust’s managers are confident, they are not complacent. Investing in biotechnology can be a risky business. A company can spend millions with no guarantee of success.
When a drug’s development reaches certain milestones, there is a high risk of share price volatility. International Biotechnology Trust has a strategy to avoid sharp price corrections.
In the run up to a significant news event announced by the company, the Trust will take advantage of investor optimism and the consequent rise in the share price. But it aims to reduce its position just ahead of that announcement.
Carl Harald explains “Sometimes it’s worth buying back the shares after the event, even if the price has risen. That’s because there is greater certainty over the outlook for the company, which justifies a higher valuation.”
This risk mitigation is supplemented with more standard strategies. For example, International Biotechnology Trust only invest in companies its managers understand.
That entails meeting often with management before deciding to include them in the portfolio. The Trust’s investments are also diversified across large, medium and small caps, with no single holding exceeding 10% of the portfolio.
The portfolio also has a 5-15% allocation to unquoted companies which are not affected by stock market volatility.
Not only does this help to better manage the risk in the portfolio but it also gives income investors access to a part of market which is usually only available to venture capitalists. International Biotechnology Trust’s shareholders can benefit from the full life cycle of a drug – from the moment of inception to potential global sales.
A biotechnology investment trust which manages its risk well and offers a consistent, sustainable dividend policy is a good way for an income investor to participate in capital growth while enjoying a decent yield.
For further information on International Biotechnology Trust, please visit the website at ibtplc.
The Trust’s latest monthly factsheet is available – click here