TIP SHEET: Fidelity Manager Sees Opportunity In Biotech Funding Crunch

A funding crunch has descended upon the biotechnology industry in recent years, which has made the sector less desirable to some investors.

But Rajiv Kaul, portfolio manager of the Fidelity Select Biotechnology (FBIOX) fund, sees the pressure on biotech stocks as an opportunity. It has allowed him to buy what he sees as higher-quality biotech stocks at cheaper valuations than in the past.

"If in general companies are having a hard time getting financed because of debt pressures, some can get unfairly penalized for that," Kaul said. "That becomes a great opportunity for investors."

His strategy has paid off this year. The $1.2 billion fund has posted a year-to-date return of 16.07% through Wednesday, ranking it third among 134 health funds tracked by Morningstar. Its category was up 6.16% year to date through Wednesday, while the S&P 500 index had a return of 0.93% for the period, according to Morningstar. Morningstar gives the fund a rating of three out of five stars.

"For investors interested in a biotechnology fund, it's a pretty good option," said Christopher Davis, analyst with Morningstar. He added, however, that few investors really need dedicated biotech funds because they are niche funds that can be volatile.

Davis said Kaul's performance since taking over the Fidelity fund in 2005 has exceeded that of actively managed biotech rivals.

Kaul also manages the $72 million Fidelity Advisor Biotechnology (FBTAX) fund, which is similar to the Select fund but sold through financial advisers instead of directly to retail investors. The Advisor fund had a year-to-date return of 16.31% through Wednesday.

Top holdings in both funds as of Oct. 31 included Amgen Inc. (AMGN), Biogen Idec Inc. (BIIB), Gilead Sciences Inc. (GILD), Alexion Pharmaceuticals Inc. (ALXN) and Vertex Pharmaceuticals Inc. (VRTX), according to Morningstar.

Biogen and Alexion each have posted year-to-date gains above 65% as of Wednesday's close. Alexion has benefited from continued sales growth for its drug Soliris, which treats a rare blood disease. Biogen has risen on improve results from existing drugs plus high expectations for an experimental multiple sclerosis drug it is developing.

Both Biogen and Alexion are emblematic of key attributes Kaul looks for in biotech stocks. Given the funding constraints, companies with existing products generating cash flows are in a better position than those that are still in the development stage, Kaul said.

"There's a clear shakeout in the industry," he said. "Smaller companies with higher-risk programs and questionable drugs are finding it much harder to raise money...It's a very tough environment. Those companies with products already are more advantaged."

Kaul said he also looks for companies with solid clinical-trial data for drugs under development. He likes companies selling or developing drugs that represent meaningful advances in medical care, as opposed to drugs that aren't much better than what is already on the market.

He said drugs with meaningful benefits have a better shot at getting reimbursed by cost-conscious health plans.

Despite the capital constraints, Kaul sees the biotech industry as being in a "renaissance period," as scientific advancements are leading to new therapies that can be combined with genetic diagnostics to increase the odds that certain drugs will work in certain patients.

"The general direction of the industry is moving forward," he said. "That creates a fertile, rich environment in looking at new ideas."

(Peter Loftus covers the pharmaceutical industry for Dow Jones Newswires. He can be reached at 215-656-8289 or by email at peter.loftus@dowjones.com.)

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