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Questor: why biotech can beat the usual drugs firms – and what makes this the trust to buy
Questor investment trust bargain: biotech drugs are fundamentally different from traditional ones and this can make them a better investment
Going “off patent” is the fate that awaits most of the blockbuster drugs that provide pharmaceutical companies with the bulk of their profits: when the patent that protects the innovation expires, other firms can make generic “copycats” and sell them for a fraction of the price. But not all drugs are affected equally and this week’s trust, International Biotechnology, seeks to exploit the fact.
Questor suspects that not all investors appreciate what makes “biotech” distinct from traditional means of drug development – and it is this difference that gives rise to the opportunity. So we will attempt to explain.
Traditional drugs, around which companies such as GlaxoSmithKline have built their businesses, originate in the laboratory and are relatively simple chemical compounds. Drugs that stem from biotech, on the other hand, derive from naturally occurring proteins and are generally far more complex molecules.
Crucially from the point of view of investors, the simple molecules behind traditional medicines are easy for the makers of generic drugs to copy, whereas the more complex biotech-derived ones are not. So before the latter can be sold to the public, regulators tend to insist that they go through the full process of clinical testing.
This makes the copying of biotech drugs much more expensive, so the originals cannot be undercut to the same extent and the maker can maintain its profit margins for longer. So, other things being equal, biotech drugs can make better investments than conventional ones.
Because of the difficult science involved, however, it takes a brave investor to put money directly into biotech stocks. Getting exposure via a fund is a better idea.
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“We like the biotech sector as a whole because there are still a lot of unmet medical needs and much of the innovation taking place to meet them is in biotech,” said Ozge Brinkworth, an analyst at Speirs & Jeffrey, the wealth manager. “In fact, about half of new drug approvals come from biotech.
“However, it is a specialist sector so it makes sense to use a fund manager with specific expertise. Individual biotech stocks are also quite risky and it’s a good idea to have diversification.” Brinkworth said there were three biotech investment trusts that investors could consider: BB Biotech, Biotech Growth and International Biotechnology.
“We quite like BB Bio but it is trading at a large premium, while Biotech Growth is on a discount but has underperformed recently,” she said. “So at the moment we prefer International Biotech.” This trust, which pays a dividend of 4pc of net asset value each year, is currently trading at a small discount of 1.1pc.
“Over five years BB has been the best performer but International Biotech has also been good, with returns well ahead of the Nasdaq biotech index,” she added. “The discount is what makes it our preferred choice now.”
The trust’s performance has improved since the appointment five years ago of the current lead manager, Carl Harald Janson, who is a medical doctor, has a PhD and has served on the boards of biotech companies. The portfolio currently has 69 holdings, of which 44 are quoted. Some of the unquoted exposure comes via a fund managed by the same company as International Biotech itself, SV Health Investors.
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“The unquoted holdings differentiate the trust from its rivals, whose stocks are all quoted,” Brinkworth said. “International Biotech’s unquoted holdings haven’t always added to performance but they do offer exposure to opportunities at an earlier stage.”
She added: “The way Janson manages risk is also interesting – he tries to avoid ‘binary’ outcomes, such as when a stock’s fortunes are tied to the success of a single drug, because the share price reactions can be big, especially with smaller companies. We think this is a good way to manage risk in the biotech sector.”
The analyst concluded: “We want to be in biotech because of the sector’s strong prospects and we are satisfied with this trust as long as it continues to outperform the index.”
Questor says: buy
Ticker: IBT
Share price at close: 604p