The brutal sell-off in biotechnology stocks has presented an opportunity for well-positioned specialist managers to exploit rare bargains in a sector which has historically outperformed the market.

We believe the International Biotechnology Trust (IBT) is a great way to get low risk exposure to this exciting space.

The trust trades at a slight discount to net asset value (NAV) and unusually in the sector, offers an attractive 5.3% dividend yield.

OPPORTUNITY KNOCKS

The key drivers behind the biotechnology sector’s long-term outperformance remain firmly in place. Ageing global populations are increasing demand for new drugs and spending on healthcare.

In addition, the pandemic has increased the pace of scientific innovation and the number of new drugs getting approved.

It is therefore rather surprising that the Nasdaq Biotechnology index is 30% lower than its peak in September 2021 and effectively trading back at pre-pandemic levels.

The valuation of the sector peaked in the spring of 2021 according to IBT’s joint lead managers Ailsa Craig and Marek Poszepczynski.

The managers commented: ‘While the biotech sector has suffered a long and historic retraction since its highs of spring 2021, the current valuations in the sector pose a compelling opportunity to tap exciting innovation at highly attractive prices – particularly within smaller players in the space, many of which are trading at a fraction of their valuations a year ago.’

Craig and Poszepczynsk have seen these cycles before and the acceleration of selling in recent weeks has got the managers pondering whether we are seeing capitulation.

One possible sign that things have become extreme is a resurgence in merger and acquisition activity.

In early May 2022 the trust was a beneficiary of Pfizer’s (PFE:NYSE) acquisition of biotech firm Biohaven (BHVN:NYSE) which was pitched at a 74% premium to the undisturbed price.

Biohaven represented 5.2% of IBT’s NAV which resulted in a 3.6% uplift in valuation for shareholders. The managers have been positioning the portfolio for an increase in mergers and acquisitions for some months.

The trust has benefited from takeovers of portfolio companies Acceleron, Vifor Pharma, Arena Pharmaceuticals and Zogenix which all received offers at a high premium to the share price.

A DIFFERENTIATED APPROACH

The trust is managed by an experienced team which has been investing in the sector for 30 years. One of the biggest risks of investing in biotech is the uncertainty of successful clinical trials.

IBT mitigates these risks by reducing exposures ahead of key clinical data releases. In addition, the team uses proprietary valuation techniques to reduce positions where the risk/reward is considered unattractive.

Another important part of risk management is the diversification across companies in different stages of development. The biotechnology index is dominated by smaller companies at the riskier end of the spectrum.

IBT deploys around 60% of the portfolio into either profitable or revenue growth companies. That is, companies with a commercially available drug on the market.

The rest of the portfolio is in earlier stage companies. The managers point out that many of these are trading at, or below, cash values.

‘We are excited about new technologies emerging in oncology and rare diseases – which are less sensitive to price regulations, as they address high unmet medical need.’

The portfolio is skewed towards therapeutic areas which have higher pricing power. This has become a more important aspect in recent months as inflationary pressures have surfaced.

Generally, the healthcare sector is more resilient to rising inflation because medical costs are not discretionary expenditures.

UNQUOTED ATTRACTIONS

Another attractive feature of the trust is its allocation to unquoted private companies. This feature gives investors exposure to otherwise inaccessible investments including venture funds.

It gives the managers a better understanding of developing trends and technologies. This part of the fund also provides some protections during heightened market volatility.

The unquoted investments represent around 7% of the portfolio.

They are overseen by Kate Bingham who is a managing partner of SV Health Managers LLP, the investment advisor.

Bingham was appointed chair of the UK Vaccine Task Force was given significant credit for the success of the UK’s vaccine strategy.

Over the last choppy six months the trust’s shares are down 9.7% compared with a 15% drop in the biotechnology index. Over the last five years the shares are up 34% compared with a 28% gain for the index.

The trust has an ongoing charge of 1.2% a year.

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