Investing in Biotech's Best
Quaker Biotech Pharma-Healthcare Fund
US > Health/Biotechnology >
Jul 01, 2003
Nov 09, 2012
Q: Sectoral Asset Management is concentrated in biotech companies. Are all accounts managed this way?
A: Ninety percent of the accounts we manage are biotech only; the rest are balanced in pharmaceuticals and biotechs.
Q: How long have you spent researching these companies?
A: We set up this firm three years ago, but I have done this for the last 10 years.
Q: The Quaker fund is a retail product. Is most of the money in private client wealth, or do you advise other mutual funds?
A: Most of it is sub advised. One big piece of it is with a European bank, Pictet. That is actually about $900 million as of March. That is distributed in Europe only. We have a relationship with Prudential based in Taiwan that is also a mutual fund. The last sub advised group is in Quebec, the DeJardin Group. We also have a long short fund.
Q: Speaking of long short, the prospectus says that the Quaker fund is allowed to sell short.
A: I think that is one of the interesting features of the fund. It is one of the rare mutual funds where you get not only a traditional long strategy, but also some opportunistic shorting, as well as the ability to be flexible in terms of cash allocation.
Q: My observation of the sector is that it makes sense to sell short because sometimes you can have your heart broken if you go long only.
A: Whether they come from technology, which has generated a lead compound that has promising indications, or whether they come from the more opportunistic side of the world where some companies have licensed a compound based on some biology they've mastered particularly well, they all start out as one product companies. Being an observer of this industry for a long time, the success rate of any one compound is actually quite low right out of the gate. You have many companies that will have their first shot on goal failing. That leads to some pretty dramatic stock performances. Indeed, there is a chronic case for taking short positions as well.
Q: How many positions are in the fund, both long and short?
A: At this point we have 27 positions. It is concentrated and that is also one of the characteristics of all the portfolios we run. It is characteristic of our investment approach. It's bottom up and it's concentrated because we believe that in an area such as this, if you can't keep close tabs on your companies, if you don't know the fundamentals of your companies, the situation at some point is going to get out of hand.
Q: What kind of criteria do you apply to sell short?
A: Usually it's going to be a combination of things. If you want to make some money here, you need to have some very clear milestones in a reasonably short time frame. As you know, stocks like these tend to move as a function of certain events. These would be approvals, a clinical event that isn't expected. The metric that we use mostly is a price to sales ratio. That is the one we feel is going to tell us that a stock is attractive or not. It is going to be our main valuation criteria on the short side. We think there are always a few situations where the market has gotten a little bit ahead of itself, so we always have a few short positions in place. As we speak, I can tell you there is about a 9% gross short position in the fund. I would probably not go much higher than that in this particular environment. If valuations start getting way ahead of themselves, we would probably increase, although we do have a natural limit in this particular fund. We can go short more than 25%.
Q: What drives these very smart people? After all, they could all have become medical doctors.
A: That is actually an interesting angle. I think intelligence has many, many manifestations. One of them is a high level of technical intelligence of knowing a particular area of science very well. Understanding a particular process particularly well, which makes you unique in your understanding and unique in your abilities to also find ways of curing a particular disease. Or, a particular intelligence in a class of compounds, a chemical or biological class which will then have applications in different disease areas. And, the successful people also have great business acumen as well. Having an idea is only part of the story. You also must be able to apply it successfully and to do that you need that acumen. I guess the appropriate word for it, one of the side effects, is unusually large egos. That is certainly a characteristic common to many of the people out there. They are human beings. They are largely driven by an opportunity to earn a lot of money. To be fair, I think that if you are successful as a researcher or as a biotech company, you are actually going to have a much greater impact on healthcare and the well-being on humans.
Q: I learned that you have a six-step investment process. It sounds simple, but is it difficult to carry out?
A: I think a lot of it is actually just applying common sense. Clearly, you need some insights and that's why we use the input of scientific advisers. That's why we spend time talking to these companies, visiting their premises to try to get as much insight as we can into their research programs, their drug classes, the way they run their businesses. It's also by looking at what the rest of the world is thinking about a particular approach. One stock we got right was Genentech. They have developed a compound that is an antibody against a well-known target, VGEF, or vascular endothelial growth factor. It is believed to play a role in the development of tumors by helping the proliferation of blood vessels. Blood vessels are necessary for tumors to survive and grow. Without new blood vessel formation, a tumor cannot grow. It then becomes an innocuous mass of cells in the body and not a threat to health any longer.
Q: Starving it to death is my layman's view.
A: That is the idea. Genentech had failed last year with the first clinical trial, which was looking at the use of that particular compound, which they call Avastin, in breast cancer. Our analysis of it was that the failure may or may not have been anticipated but the fact of the matter was the expression of that particular VGEF receptor was very low in breast cancer patients versus very high in colon cancer patients. This is the trial that they recently completed and announced results. These results, according to the company, were unusually positive. The fact that the huge difference of expression in these colon cancer patients led us to ask what people were expecting of the second trial after the failure we saw last year. As it turned out, no one was expecting a lot out of it because of the trial in breast cancer. Our thinking here was very straightforward and uncomplicated. The chances of this drug actually succeeding in colon cancer were probably much higher. Our chances of making money by going long this stock were probably pretty good. As it turned out, the results were positive, and expectations had indeed been very low since the stock went up 50% for three days after this announcement. We were into this with all our funds and the Quaker fund in particular for a few months. Our cost basis was less than $35. That is one illustration of how we try to pick stocks on common sense more than high intelligence or deep insight.
Q: A rising tide in this sector has lifted all the boats. Are we seeing a resumption of a mania?
A: I think you have to keep your feet on the ground and try to look at where do we come from? What are the performances that can be rationally explained by some tangible evidence and what is just piggy backing with the rest of them? As you allude to, first of all you look at where we came from. If you are talking about the 52-week highs in this case, it is highs off a very low base. At the same time last year, we were at the very bottom of a drastic price correction that had been triggered by one particular event, which was the ImClone affair. It put a lot of doubt in people's minds about the ability of biotech companies to bring drugs through the FDA and their honesty, etc. It also came after a particularly slow FDA approval process and high levels of aversions by the FDA that led to requests for additional safety data. That price decline in itself was an unfair exaggeration as the industry had in fact continued to do very well. Sales have been increasing 20%. That's the first thing we have to look at.
Q: Why are there no information-based companies that usually fall into the sub category of genomics in the portfolio? Are you biased toward them?
A: I would largely subscribe to that view, except that you also have to keep your eyes open for the few companies that will or that have, on the basis of that technology, tried to make some money by offering it to others. You keep your eyes for those companies that have developed their own pipeline by using that technology because that is where the value is. I tend to agree with people that say genomic companies are not in a position to capture the high margins because they offer a technology and not a product, but at the same time you have to keep your eyes open to those that are in a position to transform that technological knowledge. I think that Human Genome Sciences is maybe one of them. You're not buying that stock not based on the high price to sales ratio.
Q: Since these companies spend a great deal on research, how closely do you watch cash flows?
A: What you want to make sure as an investor is the cash actually allows you to go to the next value creator or the next milestone for you, which for a drug development company, would be Phase Two results at the very least.
Q: Approximately how many drug candidates are currently in the pipeline?
A: I think that the number of drugs in late stage trials, or when a drug can be used as a pivotal trial, is 320 to 360.
Q: How does a research staff track that much? The reports you would have to read would take you essentially forever.
A: That would essentially kill our business. No, we don't. We take a more opportunistic approach, if I may say so. It’s a bottom up approach. To give you a sense of how we approach that side of things, the number of listed biotech companies, if you take a worldwide view, is about 600. The number of companies that we think are worthy of an investment from the long side would be about 150.
Q: How many are profitable?
A: We do have a handful, and that's probably being too conservative, of profitable biotech companies. The number will vary according to who you talk to and to how people tend to define profits. Our number is around 30 companies, and that includes the companies that are going to break even at any point during 2003. It is a worldwide number as well.