The annual results for the £350m Biotech Growth Trust (LON: BIOG) reveal a massive improvement in performance after a difficult couple of years. In the 12 months to the end of March the fund made a total return of 26.5%, which was well ahead of the five percent gain in the Nasdaq Biotech index.
Most of the outperformance came during the latter part of 2023 when the markets took the view that interest rates had peaked and that a Fed pivot was on the cards. This resulted in the small caps in the sector rallying hard, an area where the portfolio is 30% overweight compared to the benchmark.
The manager believes that these emerging biotech businesses represent exceptional value. He thinks that there is greater innovation further down the market scale, which makes them prime targets for M&A activity.
The underlying portfolio
Biotech Growth is run by industry specialist OrbiMed Capital, who try to identify quality companies with exposure to the most exciting and promising new technologies. These currently include developments in the fields of obesity, oligonucleotide therapeutics and oncology.
The fund has a concentrated portfolio with the ten largest positions accounting for 42.8% of the assets. There was a huge amount of trading during the reporting period with turnover of 102% − 20 new additions and 17 sales – reflecting the fast-moving nature of the sector.
Some of the changes were due to M&A activity, with six of the holdings bid for during the financial year. If this continues then it would be expected to help the returns moving forwards.
Before investing it is important to be aware that eight percent of the fund is invested in stocks listed in China, where the valuations are exceptionally low. There are also two direct private investments, the larger of which is expected to IPO later this year.
Outlook
Despite the recent rally, the manager believes that the valuations remain attractive, with 60 companies (15% of the biotech universe) trading on negative enterprise values. They think that this should be supportive of continued M&A in the sector, especially in view of the upcoming patent cliffs for big pharma.
The broker Investec says that the Biotech Growth Trust provides exposure to a high conviction portfolio with an emphasis on mid and small-cap emerging biotech companies, which are currently the source of around two-thirds of the biopharmaceutical industry pipeline. They have just issued a buy note because of the potential for superior long-term returns, albeit with meaningful drawdowns along the way.
It could be a good time for long-term investors to get involved as the shares are currently available seven percent below their NAV. Since the start of 2023, the trust has purchased 6.9m shares or 17.3% of those in issue at the beginning of the period, with the Board intervening whenever the discount exceeds six percent in normal market conditions.
The biotech sector looks cheap compared to historical valuations and would be expected to benefit from lower interest rates. However, it is unlikely to be a smooth ride given the nature of the portfolio, especially when you factor in the eight percent gearing.