We have been fortunate. Markets have been kind. As regular readers will know, having turned more positive in the spring of last year, I expect the good news to continue. However, it remains prudent to rebalance portfolios occasionally, particularly after a good run, for one should never take the markets for granted. This has also been a good opportunity to increase exposure to favoured themes - biotech being key among them.
The Biotech case
UN forecasts of the world's population rising from nearly 7bn today to around 9bn by 2050, ageing demographics and rising expectations, all provide sound fundamentals for the healthcare sector generally. Far lower but rising drug expenditure in emerging markets - nearly $20 per head compared to $800 in the US - adds to the potential. Whatever the economic outlook globally, there is going to be a far greater demand for medicines and healthcare products.
Yet concerns about the patent cliff have clouded sentiment towards the major pharmaceutical companies and the sector generally. One can understand why. New drugs now cost a lot more to develop and take more time to bring to market – around seven to eight years on average. This leaves only 12-13 years before the patent expires and generic versions can be produced by others. As a result, although sentiment has improved somewhat recently, it continues to trail the fundamentals.
The big pharma companies are now looking to the biotech sector for the answers. The DNA discoveries by Watson and Crick in 1953, the sequencing of the human genome, and the increased power and falling cost of computer technology, has opened up a world of possibilities for the more nimble biotech companies. More than 50 per cent of new drug approvals now originate from this relatively small sector - which is a remarkable achievement given the size of the pharma research and development budgets.
Furthermore, the potential of the biotech sector can only increase. This is not yesterday's story. The great advances of the first decade of this century have emanated from essentially three technology platforms - chemistry, protein engineering and antibodies. The next decade will benefit from as many as 10 new platforms and enabling tools - including stem cells, gene therapy, antibody conjugates and microarrays. The future is very exciting and mankind is set to benefit, provided science is not stifled by short-sightedness, ignorance or prejudice.
It is therefore little surprise that a major strategic rethink has taken place in the boardrooms of these large pharma companies. Big pharma is now buying biotech. A combination of large but idle cash balances and the right biotech companies could help both sectors - but particularly the biotech sector.
And valuations continue to look attractive given growth rates. Indeed, the large biotech companies are looking especially undervalued at the moment given many trade at market average ratings yet offer far faster growth rates - 25 per cent faster being typical. Meanwhile, smaller biotech companies are relatively unloved at present. Therein lays our opportunity.
Portfolio changes
Biotech is a specialist subject. Not many generalist or smaller company fund managers have the resource and expertise to fully grasp the scientific opportunities on offer. It therefore pays to employ experts. This is why both portfolios hold Worldwide Healthcare trust (WWH) with its 20 per cent exposure to biotech. WWH is run by Orbimed Capital out of New York, which also manages The Biotech Growth trust (BIOG). The Growth portfolio already holds BIOG - the star performer within the sector, which now stands at a small premium to assets.
But I want to further add to this area. So, within the growth portfolio, I have introduced International Biotechnology trust (IBT). Run by the respected team of David Pinniger and Kate Bingham out of London, IBT has a good long-term track record and stands at a discount of around 15 per cent. Like BIOG, it aims to achieve long-term capital growth by investing in global biotechnology and other life sciences companies, mostly in the US.
However, an interesting aspect of IBT's portfolio is its 15-20 per cent exposure to unquoted investments which were a legacy of a 'C' share issue some years ago. Initially a drag on performance, they are now blossoming and recently enabled a modest upgrade to net asset value (NAV). I expect this to continue. These unquoted investments will also help to reduce the portfolio's volatility somewhat.
Being positive about the pharma/biotech sector in general, and because neither BIOG nor IBT has any yield, within the income portfolio I have added to existing holdings of WWH with its near 2 per cent yield. Despite its discount narrowing since first introduced to both portfolios - currently standing at around 6 per cent - it remains attractive given its superb performance over the years.
Meanwhile, outside the biotech theme, I have continued to pursue the 'Go high' element of the 'Go high, go deep, go east' strategy which has guided both portfolios since inception - for reasons again highlighted in my last column 'Great rotation or expectation?' (5 April, 2013). Accordingly, within the growth portfolio I have added to existing holdings of the iShares Corporate Bond ex Financials ETF (ISXF). Within the income portfolio, I have added to three holdings – the iShares Corporate Bond ETF (SLXX), New City High Yield trust (NCYF), and Murray Income trust (MUT).
I also remain positive on the outlook for Japanese equities having largely ignored the country up to the end of last year. Consequently, within the growth portfolio I have added to existing holdings of the iShares Japan Monthly £ Hedged ETF (IJPH) for reasons cited in my column 'Japan: A once-in-a-lifetime opportunity?' (8 February 2013). Within the Income portfolio, I have also introduced JPMorgan Japanese trust (JFJ), which stands on an 8 per cent discount and yields a short 2 per cent.
To help fund these purchases, within both portfolios I have sold BlackRock Smaller Companies (BRSC) and Middlefield Canadian Income (MCT). Both remain excellent trusts. But a narrowing discount after a strong run by BRSC, and with MCT now standing at a strong premium, I felt better opportunities existed elsewhere - particularly given recent events in Japan. For similar reasons, I have also sold Golden Prospect Precious Metals (GPM) within the growth portfolio, although I remain positive about gold in the longer term.
Finally, for the record, the performance and asset allocation figures are as of 3 May - circumstances this month did not allow me to measure statistics at the usual month-end.
