This financial promotion is issued and approved by SV Health Managers LLP ("SVHM"). Notwithstanding that this document is being provided to you as a financial promotion, you should be made aware that the opportunity described in the document is not suitable for all investors. Before investing in the Company, or any other investment product, you should satisfy yourself as to its suitability and the risks involved, and you may wish to consult a financial adviser. The value of investments, and the income from them, may go down as well as up, and is not guaranteed, and investors may not get back the full amount invested. Past performance is not a guide to future performance and exchange rate changes may cause the value of overseas investments to rise or fall. Please see Risk Warning on the attached Factsheet.
When biotech companies undertake clinical trials, the outcome is often binary - either the drug is shown to be safe and effective, or it is not. Many biotech companies are formed around just one potential drug, so if that one drug turns out to be unsafe or ineffective, the value of the company will plummet. This makes for a volatile investment environment. The volatility is further exacerbated by cyclical valuation drivers caused by the sector coming in and out of favour with investors and the macroeconomic environment. More mainstream sectors, such as the energy sector, are a mainstay of most investors’ portfolios regardless of market conditions. However, investors tend to view biotech as an optional sector, to be entered when markets are booming, and to be abandoned when it seems the markets may turn negative.
Experience and expertise
Specialist biotechnology fund managers do not have the option of leaving the sector and returning at a later date. It is their job to navigate this volatile investment environment and preserve the capital in their fund while doing so. This requires experience and expertise. Experience allows the investor to identify where the sector is currently sitting in the valuation cycle and position the portfolio accordingly. Expertise gives the investor the insight that reduces the risk of being heavily invested in companies whose treatments may fail.
Ailsa Craig and Marek Poszepczynski have been working together on the management of International Biotechnology Trust (IBT) since 2013 and took over as joint lead managers in 2021. Over their decade managing the trust, they have developed a rigorous investment process aiming to outperform the index while keeping volatility below that of the index.
Positioning the portfolio according to the valuation cycle
Key to reducing volatility in a portfolio of biotech stocks throughout this investment cycle is to know where the cycle is at any one time and use experience and expertise to benefit from it. To attempt to minimise volatility, managers need to be very conscious of the sector’s investment cycle and position their portfolio to exploit these inevitable shifts in valuations. IBT sees the cycle as follows:
Within the biotech sector there are highly profitable companies with multiple launched drugs and valuations in excess of US$50 billion, companies with a newly launched drug which are not yet making a profit but have high growth expectations and profitability in sight, and at the other end of the spectrum are the more speculative companies in development stage, still working their way through the highly risky process of clinical trials.
Companies that already have established drug sales and are turning a profit are somewhat – like a utility in character. Sales tend to be predictable, based on the number of patients with the condition, and prices are pre-agreed, therefore earnings are visible. Naturally, these companies are usually less volatile during a correction and the resulting period of despair, and tend to be a safer haven for investors trying to weather a storm. Conversely, in a period of established equilibrium and the resulting euphoria, drugs in the early stages of development tend to attract speculative investors, excited by the prospect of new science to address previously untreatable conditions, and so will be particularly buoyant during these periods. However, they will be most exposed to a market downturn when investors will typically desert the companies they deem to be the most risky.
This blog is not providing investment advice and the above does not mean that investors should only buy profitable companies during a correction and only buy early stage companies during periods of tranquillity: there is always value to be found in all pockets of the biotech market as well as the possibility of many other events that may affect a company’s valuation irrespective of market conditions. The underlying drivers of the sector – rising demand from an ageing population and a growing global middle class combined with accelerating innovation in the healthcare industry, - are consistently moving in a positive direction. However, history indicates that during periods of correction and recovery, it is key to tilt the portfolio to be overweight in the segment of the biotech sector that is most likely to outperform. Beyond that, it is important to find the most resilient companies in other segments, to mitigate downside.
Valuation analysis and trading discipline
Understanding biotech valuation is an important tool in managing a biotech portfolio. Having the skill to identify when a stock’s value is overheated and making the difficult decision to sell it, even if it is a favourite stock pick, comes with experience. In a portfolio of stocks where values can move 20-30% or more in a day, it is important to keep on top of the value of every stock, to spot situations where a value needs to be locked in and capitalised through a sale, in anticipation of a correction.
Keeping in mind that the stock can be bought back once the valuation is normalised, is helpful and can mean that stocks are bought and sold multiple times during their time in a portfolio. Conversely, when valuations are depressed, having the expertise to identify the undervalued companies which have a potential catalyst for recovery and sufficient finances to weather the period of despair is crucial.
It would be right to assume that the volatility of the biotech sector is fairly high compared to other sectors. This is further exacerbated by the high risk milestones that are inherent to the drug development process. There are various tools with which a fund manager can use, with the aim of cushioning investors from some of this volatility. The most obvious is to hold a diversified portfolio of stocks, spread across all segments of the market, by size, product speciality and development stage. In addition to this, an experienced fund manager can choose to trade around impending binary events. IBT’s fund managers aim to reduce their holding from an overweight position in a stock as it approaches one of these binary milestones. Thanks to the inherently optimistic investor mindset, stocks tend to trade up in anticipation of major news. At that point, good fund managers can de-risk the position by selling down to the index weighting or below. If the news that emerges is positive, they can choose to buy more shares as the risk is now much lower, or if it is negative, they avoid the sharp fall that tends to follow. This strategy prioritises capital preservation above seeking maximum rewards regardless of the high risk.
Value for money
Investors in the biotech sector have a choice of ways in which to invest. They could invest in companies directly, but would lose the diversification of a fund and expose them to single company risk. With consumer duty legislation upon us, considering value for money is important. Within funds, investors could choose an ETF which would be the cheapest option but would simply give them constant exposure to the entire sector with no quality filter and without access to the expertise or experience of a specialist fund manager whose skills may generate superior returns as explained above.
Alternatively, at the most expensive end of the scale they could choose a fund specialising in biotech venture which has the potential to offer a higher return over time, but would typically expose them more to the high risk and volatility in the sector. Identifying a fund which is reasonably priced in fees, gives access to a curated range of investments across the spectrum of the sector, and benefits from the expertise and experience of specialist fund managers can offer value for money.
In IBT, investors gain access to investments across the spectrum of the sector with around 8% of the trust in two funds of earlier stage venture assets and the rest in a carefully curated, actively managed, diversified basket of listed stocks. IBT’s ongoing costs and fees are 1.4%*, which compares with 0.35%** for a NASDAQ Biotech ETF such as Blackrock’s iShares Nasdaq US Biotechnology UCITS ETF, so it could be said that the experience and expertise of the managers costs investors just a percent per annum. In as sector as specialised and complex as biotech, it is perhaps easier to understand the value in paying extra for a manager with specific stock picking expertise.
By actively exploiting the valuation cyclicality in the market, trading around binary events and holding a diversified portfolio, IBT’s managers seek to use their long experience and their expertise to strive to deliver long term stability from a volatile sector to their investors.
* see page 29 of the latest interim report for a full explanation of IBT’s fee structure which also can include an incentive fee should the fund outperform the benchmark index plus a hurdle.
** as seen on Hargreaves Lansdown website https://www.hl.co.uk/shares/shares-search-results/i/ishares-nasdaq-us-biotechnology-ucits-etf/costs
The IBT Team is planning to present an update on the trust at the Mello Investment Trust Webinar on 18th July 2023. More details on how to participate are available by registering on https://melloevents.com/upcomi...
This financial promotion is issued and approved by SV Health Managers LLP ("SVHM") which is authorised and regulated by the Financial Conduct Authority. Notwithstanding that information in this presentation is being provided to you as a financial promotion, you should be made aware that the opportunity described herein is not suitable for all investors. It should not be relied upon to make an investment decision; any such investment decision should be made only on the basis of the fund scheme documents and appropriate professional advice.
The value of investments, and the income from them, may go down as well as up, and is not guaranteed, and investors may not get back the full amount invested.
Investors should bear in mind that investment in biotechnology shares can be subject to risks not normally associated with more developed markets or stocks. Investing in the biotechnology sector carries some particular risks and investment in the Company should be regarded both as long term and as carrying a high level of financial risk. In addition, there is no guarantee that the market price of shares in investment trusts will fully reflect their underlying NAV and it is not uncommon for the market price of such shares to trade at a substantial discount to their NAV.
The Company’s portfolio companies are subject to change and should not be construed as research or investment advice. Similarly, any reference to a specific company does not constitute a recommendation to buy, sell, hold or subscribe in any company or its securities.
Every effort is taken to ensure the accuracy of the data used in this document, but no warranties are given.
All views expressed in this document are current as of the date of this presentation and may be subject to change.
Full details of the Company, including risk warnings, are published in the Key Information Document and Investor Disclosure Document which are available on request and at www.ibtplc.com.