Watch out for the new biotech bubble

"Big biotech valuations remain below average but discovery biotech is a bit foamy," he says. "People are paying out for dreams. I'm not nervous about the valuations on big biotech but I have less invested in emerging biotech now than four months ago because I've been concerned about the valuations there."

Emerging biotech stocks, many of which do not even generate a profit, account for 20.3 per cent of the trust's portfolio.

It is a quick return to frothy territory for biotechnology stocks, which have only recently emerged from a volatile 2015 and 2016. In the run-up to the US election, presidential candidate Hillary Clinton said she would take action on high drug prices and this popped the biotech bubble that had been building for several years. Over 2016 the Nasdaq Biotechnology index fell 6.2 per cent..

Worldwide Healthcare invests across various types of healthcare, biotech, pharma, services and equipment companies, and that diversification has insulated it from the most chaotic gyrations of the high volatility biotech sector. The trust delivered a positive share price return of 10.1 per cent in 2016.

And its long-term share price cumulative returns are good, too, with the trust returning 476.8 per cent against 249.7 per cent for its benchmark, MSCI World Health Care, over 10 years. In the year to date it has returned almost double its index with a share price return of 20.2 per cent.

This year's good return is due to a recovery in the sector generally but also because of outperformance by stocks such as private Chinese eye hospital Aier Eye Hospital (CH:300015) and medical device maker Wright Medical (US:WMGI). Wright Medical is the trust's second-largest holding and was initiated as a contrarian position. Its share price had fallen due to the arduous integration of an acquisition in 2015 and ongoing litigation. But it has turned things around and was the top contributor to Worldwide Heathcare's performance in its last financial year. 

High-risk, early-stage companies such as BeiGene (US:BGNE) were also responsible for recent performance. BeiGene is one of Mr Isaly’s crop of "discovery biotech" stocks whose performance hinges on a knife-edge based on whether or not the drugs they are working on succeed.

Despite being a lower-risk option than pure biotech trusts such as Biotech Growth Trust (BIOG), which Mr Isaly also manages, a major chunk of Worldwide Healthcare remains invested in nascent biotech companies that do not yet generate profits, and whose success hinges on the success or failure of landmark drugs. Of the 25 companies Mr Isaly counts in in his 'discontinuous growth' selection – his highest-risk group of stocks – only one fifth are generating profits.

Mr Isaly also invests in value stocks with depressed share prices whose performance depends on a turnaround in market sentiment. These include larger companies such as Novartis (US:NVG), which has just released the most expensive ever cancer treatment and one of the most expensive drugs of all time, which costs $475,000 (£350,682.91) per patient. The chimeric antigen receptor therapy (Car-T) treatment is the leading hope for cancer treatment which could cure patients with a single dose.

To compensate for the risk that the high-risk, non-profit generating chunk of his portfolio poses, Mr Isaly also invests in companies generating top-line growth upwards of 15 per cent. These top performers include Alexion Pharmaceuticals (US:ALXN) which is working on drugs to cure rare diseases, Illiumina (US:ILMN) which is building gene sequencing equipment and artificial heart valve producer Edwards Lifesciences Corporation (US:EQ).

Returns from these companies come from share price performance but they are also takeover targets. Mr Isaly says that around 3 per cent of the trust's 16.6 per cent annualised total return since inception has probably come from holding acquisition targets. "Typically, three companies in this portfolio will be taken over each year," says Mr Isaly, adding that Illumina, Edwards and Alexion could be taken over.

The biotech mergers and acquistions market has also heated up in recent years as big biotech and pharma companies have shied away from developing their own drugs in favour of snapping up the smaller companies with potentially exciting discoveries. And with the formerly expensive Nasdaq Biotechnology index still trading on a rare discount to the S&P 500, that looks set to continue.

There is a notable absence from the trust's portfolio. Over the past 12 months Mr Isaly has scrapped all hospital companies – a stark change considering HCA Healthcare (US:HCA) used to be the trust's largest holding. And with healthcare stocks leading the surge in US stocks in recent months, riding high on President's Trump likely failure to replace former President Barack Obama's signature health insurance programme, the lack of exposure to them has detracted from the trust's performance, although it is still beating its benchmark.

But with US president Donald Trump pledging to dismantle the current US healthcare system which provides insurance to low-income Americans, and the number of Americans using hospitals falling, Mr Isaly is concerned about the sector. 

WORLDWIDE HEALTHCARE TRUST (WWH)

Source: Morningstar, as at 21.09.17 & *Worldwide Healthcare **The Association of Investment Companies (AIC)

Performance

Source: FE Analytics, as at 18.09.17

Top 10 holdings, as at 31 July 2017 (%)  

Source: Worldwide Healthcare

Geographic breakdown, as at 31 July 2017 (%)  

Source: Worldwide Healthcare