Questor: we sold one trust because it had 17pc in one firm. Why are we tolerating 25pc now?

Questor Income Portfolio: a loan made by BioPharma Credit will account for 25pc of its portfolio – here's why it is not prompting us to sell

Richard Evans 2 October 2020 • 5:00am

Scientist in a lab — BioPharma Credit has never had a default and has large collateral against its biggest loan Credit: Christopher Pledger

“Concentration risk” is what City analysts call the dangers posed when funds have a large proportion of their money in one particular asset. If 20pc, say, of a fund is in one company and that company goes bust, every investor in the fund loses a fifth of their money overnight. No sensible saver would want to take that risk.

It was exactly this concentration risk that made us advise readers to sell one investment trust, European Opportunities, in March last year. At one stage this fund had more than 17pc of its money in one stock, Wirecard, a German payments firm – and Wirecard did indeed go bust, although the trust had, fortunately for its shareholders, sold its stake before then.

Why are we talking here about an investment trust that has never featured in our Income Portfolio? Because, coincidentally, the problem of concentration risk has reared its head at an investment trust that is part of our portfolio.

BioPharma Credit is an unusual fund because it lends money to companies rather than owns stakes in them, lends directly rather than by buying their bonds and concentrates on the drugs sector. It is by all accounts extremely choosy about who it lends money to and while this selectiveness is welcome it can result in a fund that involves just a small number of borrowers – nine at present.

One of those borrowers, Sarepta Therapeutics, which makes treatments for muscular dystrophy, will shortly draw a second tranche of a loan already agreed with the trust. The amount it has already borrowed represents 13pc of the trust’s assets but drawing the second tranche will cause its liabilities to the trust to represent a quarter of BioPharma Credit’s portfolio.

If Questor got cold feet over one trust’s 17pc exposure to one company, surely we have to sell a trust that has 25pc of its assets committed to a single firm? In fact we think there are several important differences between what went on at European Opportunities and the position with BioPharma Credit – enough to allow us to stick with the latter fund, if not without some hesitation

The first point is that European Opportunities invests in shares while BioPharma Credit’s assets are loans. Owners of shares invariably lose everything when a company goes bust, as Wirecard’s former owners can testify. It’s different for lenders. When a business goes under, ownership of its assets in essence switches from the shareholders to the lenders.

If there are enough assets, lenders will get all their money back, even if they had no specific security.

But BioPharma Credit does have security for its loans to Sarepta. Earlier this week Questor spoke to one of the trust’s managers and quizzed him in some detail about the loan.

Pedro Gonzalez de Cosio is the head of Pharmakon Advisors, which runs BioPharma Credit. He said the loan to Sarepta was secured against the intellectual property connected with two of the firm’s drugs, Exondys and Vyondys, which are successful treatments for muscular dystrophy in children. He said he had never come across drugs that had greater acceptance among doctors and patients.

While things don’t stand still in the pharmaceutical sector and even better treatments could come along to dislodge Exondys and Vyondys from their current position, developing drugs and getting them approved takes time and could not realistically happen in this case before both tranches of BioPharma Credit’s loan to Sarepta were repaid, which will take place in 2023 and 2024, Mr Gonzalez de Cosio said.

The trust also has security over the company’s cash balance, which has varied between $600m (£465m) and $2.2bn over the past three years. The value of the loans made to Sarepta by the BioPharma Credit trust and similar private funds managed by Pharmakon will be $550m when the second tranche is taken. This, in Mr Gonzalez de Cosio’s words, represents “substantial over-collateralisation”.

He added: “We are very conscious of risk. We have had no defaults in our 11-year history. We feel really no doubt in our minds about the quality of our loans.”

He said he intended to reduce concentration risk as the fund grew. “It should be a $2bn fund in the near future, maybe in a year’s time. This should take our maximum position to about 20pc.”

Questor says: hold

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