No matter how enthusiastic one is about a particular market or sector, investors should always try to maintain a balance within their portfolios in part by pruning overweight sectors. Regular readers will know that I am very positive about the biotechnology sector but, after a tremendous run, the time has come to take profits – whilst retaining a significant exposure. With the proceeds, I have increased exposure to the UK market and commodities sector as both look attractive on a medium term view.
Biotechnology update
Back in the Spring of last year, the biotechnology sector hit some turbulence and prices fell sharply. I suggested in my column (‘Sticking with Biotech’, 9 May 2014) that investors keep their nerve and, particularly if underweight, seize the moment and buy. Since then, the sector has indeed bounced, with International Biotechnology Trust (IBT) more than doubling in price.
This recent period of good performance reinforces a tremendous longer-term track record. The Nasdaq Biotechnology index has risen around 200 per cent and 300 per cent over three and five years. I suggest the outlook for the sector remains positive. The DNA discoveries of Watson and Crick in 1953, the sequencing of the human genome, and the falling cost yet increased power of computer technology, has transformed the potential and efficacy of biotech companies. An emphasis on innovation, and better managements reinvesting positive cash flow into new research & development has created a virtuous circle. No wonder the large pharmaceutical companies are circling. The future indeed looks bright provided science is not stifled by prejudice or vested interests.
And the sector, despite its strong run, is not overvalued. When I last looked, PE growth (PEG) ratios of around 1.3 times are not cheap – but they are not expensive. The sector offers high earnings growth, as evidenced by a number of recent and very successful drug launches. Indeed, during the last couple of years, for the first time the sector accounted for more than half of all new drug approvals.
Such earnings growth will continue to be increasingly prized at a time when the economic backdrop generally is challenging. I have long argued that, with debt levels so high, economic growth will prove more sluggish than usual at this stage of the cycle. Within their equity weightings, investors will therefore be wise to favour ‘growth’ over ‘value’.
But portfolio balance remains important. After its recent strong run, biotech exceeded 12 per cent of the Growth portfolio. Recognising the sector’s volatility, I have therefore top-sliced IBT having seen the trust’s discount more than halve. IBT remains the larger of my two biotech trusts and, needless to say, I retain a sizeable sector weighting. As if to emphasise the point, biotech presently represents nearly 18 per cent of my website’s higher risk Thematic portfolio.
Finsbury Growth & Income Trust
With the proceeds, I have increased the Growth portfolio’s exposure to the UK, by adding to Finsbury Growth & Income Trust (FGT). This is a market that has essentially gone nowhere over the past year despite an economy that is recovering well relative to many others within the G7 and beyond. Sentiment trails fundamentals perhaps in part because of its high weighting to commodities and the upcoming general election. This has left the market’s PE trading below its long term average, whilst offering a handsome yield.
It’s time to catch up. A favourable economic back drop, signs that the worst of the commodity price falls may be behind us, and a general election that is priced in – I believe the Conservative party will be returned with an overall majority, helped by the fact it is the only Party willing and able to deliver an EU referendum – will come to be recognised by the market.
And what better way to increase exposure than via FGT. Run by Nick Train, the trust has a tremendous track record. NAV returns of around 10 per cent, 80 per cent and 150 per cent over one, three and five years compare to the FTSE All-Share returns of around 5 per cent, 40 per cent and 60 per cent. Healthy dividend increases over the years, supported by good revenue reserves, add to the attraction - the present yield of 2 per cent reflecting FGT’s superior price performance.
Nick can be described as a thematic investor. In particular, he focuses on companies which possess internationally recognised brands which can be distributed globally. Companies with good intellectual property – expertise which can drive profits – are another favourite.
Such companies tend to have the competitive advantage of a 'wide moat’ – access to their market by others or newcomers not being easy. In a world where economic growth is hard to find yet globalisation threatens increased competition, such defensive criteria will be increasingly helpful – and rewarded.
Indeed, this disciplined thematic approach helps FGT see beyond immediate financial metrics and valuations in identifying what eventually become very profitable investments over the longer term. Once identified, it then tends to stick with the company. Consequently, portfolio turnover is very low – typically being less than 10 per cent a year.
Investors need to be aware that this focus tends to differentiate FGT when it comes to the companies held. Typically, in the UK Income growth sector, many managers have common holdings such as Shell, GSK, BAT, Vodafone and HSBC etc. In contrast, when I last looked, FGT held the likes of Unilever, Diageo, Reed Elsevier, Burberry, Pearson and Heineken – companies with either strong brands or intellectual property, or both.
This difference of approach does occasionally result in volatility and periods of underperformance. But an investor cannot beat the benchmark by copying it – to outperform, you have to invest differently. This is what FGT does and over the longer term its track record speaks for itself.
So, a fund manager at the top of his game, the pursuit of themes which merit support, and a strong dividend track record, more than make up for the fact that FGT was standing close to par when I topped up the Growth portfolio’s existing holding.
Other portfolio changes
Meanwhile, within both portfolios, during January I have also increased exposure to the commodities sector after its very poor recent run – adding to the Growth portfolio’s existing holding of City Natural Resources High Yield Trust (CYN) when on a 22 per cent discount, and adding to the Income portfolio’s existing holding of BlackRock Commodities Income Investment Trust (BRCI) when offering a near 7 per cent yield.
Space here does not allow an adequate explanation – suffice to say, the sector now looks attractively priced on a medium term view, not withstanding the prospect of more volatility. I shall cover this in next month’s column.
