Buy Biotech Growth to ride the Trump relief rally

Biotech stocks sold off before the US elections on 8 November due to fears over presidential candidate Hillary Clinton's planned crackdown on 'price gouging' in the biotech and pharma industry. But as well as being volatile over the long term, biotech has been an outstanding source of returns: in 10 years the Nasdaq Biotechnology index has returned 460 per cent, and now the market is bouncing back again, fuelled by the belief that President-elect Donald Trump doesn't plan to crack down on the industry in the same way as his rival.

Biotech Growth Trust, meanwhile, has comfortably beaten the Nasdaq Biotechnology index over five and 10 years, but is trading on a wider-than-average discount of 8.1 per cent compared with a 12 month average of 6.8 per cent.

It has a highly concentrated portfolio with just 35 holdings, divided between large-cap biotech companies generating healthy profits, mid-cap emerging biotech companies in the process of launching their first drug and early-stage emerging biotech stocks expected to deliver fast growth.

Over 10 years it has generated the best returns of all the investment trusts in its sector, returning more than 500 per cent against a sector average of 327 per cent, and easily beating the Nasdaq Biotechnology index. And the trust returned 328.7 per cent over five years compared with 291.9 per cent for the index and its sector average of 227.9 per cent.

The trust is also well positioned to take advantage of depressed valuations in the biotech sector, which remain at historic lows. The biotech sector was trading on a PE ratio of around 11 at the end of October compared with a long-run average of 23. It was also trading at a rare discount to the S&P 500, which had a PE ratio of 16.

Large-cap biotech valuations are particularly attractive relative to history and other sectors, and Biotech Growth's manager, Geoffrey Hsu, has been shifting towards those in recent months so that the trust has around 60 per cent of its assets in large-cap stocks. Those include Gilead (US:GILD), Amgen (US:AMGN), Celgene (US:CELG) and Biogen (US:BIIB), which is currently working on a breakthrough treatment for Alzheimer's.

The trust also invests in smaller-cap companies such as Incyte Corporation (US:INCY), which is working on a treatment for lung cancer and could be a takeover target in the new year if dealmaking activity picks up again.

In recent months the trust has lagged its benchmark due to having higher gearing (debt) than its peers. The trust's share price suffered when the market fell from its peak in July 2015 and in the year to date it has lagged the Nasdaq Biotechnology index.

Its ongoing charge of 1.04 per cent, meanwhile, increases to 1.54 per cent when its performance fee is taken into account, so is a good deal higher than the ongoing charges of a number of open-ended funds focused on this area.

But the performance of this trust has been far superior to these, justifying the price tag.

And broker Winterflood says: "While Biotech Growth Trust has suffered disappointing performance in a challenging period for the biotechnology sector, its long-term performance record remains strong. We continue to believe that over the longer term [its manager] OrbiMed's experienced and specialist team will enable the fund to continue to outperform its benchmark."

So if you have a high risk appetite, and want to buy into a sector with good long-term growth prospects but whose valuations are at long-term lows, Biotech Growth Trust, while on a wider than average discount to NAV, looks like a good option. Buy.

Source: Morningstar, as at 15.11.16 *Winterflood, as at 15.11.16

Performance

Source: FE Analytics, as at 15.11.16

Top 10 holdings as at 30 September 2016 (%)

Source: Frostrow Capital

Geographic breakdown (%)

Source: Frostrow Capital