Harnessing the power of biotech for income and growth
With a pandemic sweeping the globe and causing panic in stock markets, investors may be looking for ways to tap into scientific innovation, while also diversifying in the face of a punishing sell-off. Biotechnology ticks both boxes and owning the theme through an investment trust can bring even more benefits.
International Biotechnology- Trust (IBT) invests primarily in US-based drug-makers with a global reach that meet a medical need for consumers.
It holds companies from across the space, including established mega caps and smaller, early stage businesses, including some that are unlisted.
IBT is also the only biotech trust which caters to income-seeking investors, offering an attractive dividend of 4% of NAV as well as the potential for rapid capital growth.
Led by Carl Harald Janson, a medical doctor by background, IBT’s investment team seeks out those businesses which can produce strong top-line growth. For this they need intellectual property which gives them pricing power and a competitive edge or monopoly.
‘intellectual property which gives them pricing power and a competitive edge or monopoly’
More than half the portfolio is invested in companies working in the specialisms of oncology (the treatment of cancer) and rare diseases, where barriers to entry are high.
For example, one of the largest positions in the fund is in Vertex. A growth story in the treatment of rare diseases, it dominates the cystic fibrosis space, treating around 90% of patients.
IBT’s investment managers prioritise direct contact with senior executives at biotech companies to gain a deep understanding of these businesses and their future prospects and challenges.
Around 36% of IBT is invested in companies that are already profitable, while around 31% is in businesses at the development stage which the manager thinks will turn a profit in future.
At the geographical level, the fund is heavily skewed towards the US, the home of the biotech industry.
It is well diversified across the market-cap spectrum, and holds, directly and indirectly, approximately 100 companies at different stages of development working in a range of therapeutic areas.
The portfolio is predominantly in large and mid-caps, although it also holds some small-cap companies of less than $1bn in size.
‘unique access to venture capital-style investment opportunities’
Alongside the names in its listed company portfolio, IBT also has a smaller portfolio of unquoted biotech stocks, most of which are held through an investment in a venture fund, SV Fund VI.
This unquoted portfolio has proven itself to be an excellent diversifier, making a significant contribution to performance last year when biotech stocks as a whole struggled, as investors shunned risk, and acting as a stabilising factor in the recent COVID-19 triggered sell off.
It offers unique access to venture capital-style investment opportunities that are well suited to the investment trust structure because it doesn’t face the same potential redemption pressures as an open-ended fund.
The M&A advantage
Roughly two-thirds of the development of new drugs happens within smaller companies, while two-thirds of their commercialisation happens in large companies.
This explains why merger and acquisition activity is so frequent within the biotech space, as big firms take ownership of new drugs that they can distribute across their global networks.
For IBT, this has been a happy side effect of choosing the strongest companies with the best valuations: 16 of the portfolio’s holdings have been M&A targets since 2017, with an average 58% premium paid on the deals.
A careful sell discipline helps the trust to keep a lid on volatility. Biotech is naturally volatile because a company’s fortunes can pivot on the results of a single drug trial.
IBT’s managers attempt to reduce the impact of binary events that could send share prices up or down.
What this means in practice is that they will reduce their exposure before the results of a critical trial, for example. While they might lose out on some of the last bit of outperformance from a stock by doing this, it also means they won’t be so affected by a sharp share price fall if the trial ends unsuccessfully and can always increase their holding at a later date.
A rare yield
The International Biotechnology Trust is the only one of its peers to pay a yield.
Following a dividend policy introduced in 2016, the dividend of 4% of NAV per annum is paid from capital – effectively converting some of the underlying holdings’ capital growth into income each year – making the trust a compelling option for income-seekers as well as growth investors.
‘a compelling option for income-seekers as well as growth investors’
Given that this dividend is paid from capital, it is not contingent on receipt of income from underlying portfolio companies.
This policy helped bring in the trust’s discount to net asset value over the past 3 years, although the discount widened again during the recent market sell off.
Delivering an annualised return of 15% a year over the last decade, biotechnology has outperformed the annualised 8.75% return from the MSCI World over the long term*.
The sector offers diversification, innovation and compelling growth potential for those investors willing to take some risk over the long term.
*Source: SharePad and MSCI (annualised % change of the Nasdaq Biotechnology Index versus the MSCI World 28/02/2010- 28/02/2020)
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