Eaton Vance's Healthy Fund Formula


James A. Anderson Biotech and pharmaceutical shares got a healthy boost in October, chalking up an average gain of 5%, according to Morningstar figures. That's pretty impressive, compared to the rather anemic 1.9% increase that the Standard & Poor's 500 has eked out.

The robust showing is the result of a combination of factors. Medicine makers have reported steady earnings, while most other sectors have had dismal results. Investors have also seen these companies as havens during recession, and worries about bioterrorism have also boosted their shares.

BIG GROWTH AHEAD. These catalysts have also done wonders for the gene-splicing, drugmaking companies held by Eaton Vance Worldwide Health Sciences Fund (ETHSX). Over the three-month period ended Nov. 16, the fund, managed by Samuel Isaly, has returned 3.7%, while the S&P 500 has fallen 3.3%.

Isaly, who works for OrbiMed Advisors, the investment firm that oversees the Eaton Vance fund, works with a team of 12 to comb through some 600 companies. He focuses on pharmaceutical outfits and biotech players because he thinks big growth lies ahead for both areas. By his estimates, big pharma should log a 15% average annual earnings climb over the next five years. Biotech at large, he says, should be looking at 20% or more earnings growth annually.

One thing Isaly looks for in individual companies is financial girth, which will give them the ability to survive while waiting for their products to reap rewards. "They probably won't last, so there's no reason to get in," he says of the companies without deep pockets. Isaly also steers clear of a couple of health subsectors -- medical-device outfits and health-management concerns -- because he doesn't think they have the potential profit growth that he's looking for.

CONSISTENT SHOWING. Another distinguishing characteristic of the Eaton Vance portfolio is its large stake in overseas concerns. Like its peers, it sports a base in such household names as Pfizer (PFE), Bristol-Myers (BMY), and Merck (MRK). Among the overseas players it likes: Swiss companies Serono (SRNBF) and Novartis (NVSDF). Morningstar data show Isaly had just over 30% of his assets invested outside the U.S. as of Aug. 31, while the average for his health-fund peers was just 8.2%.

Isaly is also more heavily exposed to biotech names: Some 40% to 45% of his portfolio is in such companies, compared to approximately 20% for his peer group. Among the companies he likes: Sepracor (SEPR), Genentech (DNA), and Immunex (IMNX). "The fund certainly has found a way to take some very volatile stocks and combine them in a portfolio that has put up remarkably steady results," says Morningstar analyst Peter Di Teresa.

Since Jan. 1, Isaly's fund has backtracked 10.4%. Year-to-date, it's in the top 22% of all health-science funds, according to Morningstar. Isaly says he's not concerned about short-term rankings. "Year-by-year, where we stand [in] any 12-month period isn't important," he says. "To me, our long-term record is what's important, and we're doing very well."

LONG-TERM STANDOUT. Last year, the fund turned in an impressive 81.6% total return, some 91 points beyond the S&P 500. Over the past three years, the $1.76 billion fund has managed a 31.5% annual climb, almost 30 points beyond the S&P 500, and enough to place it in the top 8% of health funds. For the 10-year period ending Oct. 31, the fund is in the top 1% of its category with a 20.7% average annual total return.

As Isaly sees it, the fund's holdings tend to fall into three categories. Roughly 20% of his investments gravitate to bottom-fishing picks, such as Sepracor, Abbott Labs (ABT), Genentech, Immunex, and Schering Plough (SGP). The fund manager says these stocks looked too good to pass up when their prices dropped. An additional 20% of his portfolio (and no more due their risk) is set aside for more speculative picks, such as Praecis (PRCS) and OraPharma (OPHM).

The remaining 60% or so is "companies that we saw were moving up and are still moving," as he puts it. Anchored in such holdings as Pfizer, Serono, and Novartis. This portion of the fund's money helps counter the speculative nature of some of the more risky picks. That solid base also helps Isaly keep turnover to a low 31% yearly. By comparison, consider that Isaly's peers average a 315% shuffling of positions over the course of a year.

"MAJOR IMPACT." One stock Isaly particularly likes now is Immunex, a biotech that has developed treatments for arthritis, cancer, and multiple sclerosis. He says he swooped on its shares in late March when its shares fell from the $20 range to $11. Immunex was having trouble ramping up production capacity to produce Enbrel, a medication used to treat rheumatoid arthritis. Since then, the company has broken ground on new labs to double its Enbrel production capacity, and it has won back Wall Street's support, rising to close last Friday at $26.02. Isaly, who has paid an average of $13.55 a share for it, thinks Immunex shares could rise a further 50% in the next year.

Isaly has built a position in Genentech with an eye on three new products it has in development. One, Avastin, treats solid-tumor cancers, while Xanelim is a psoriasis medication. Another potential winner in the pipeline is Xolair, a treatment for asthma. "The catalyst for this stock is the fact that each of these products could have a major impact," he says.

Meanwhile, sales for Genentech's lymphoma drug Rituxan remain strong. Isaly says he jumped on Genentech shares when the stock was priced in the low $40s. He feels the company's shares, which closed Nov. 16 at $55.29, could make a 50% gain in the next 12 to 18 months.

"FIELD OF DREAMS." Supply and demand will continue to work in his fund's favor, Isaly reasons. An aging U.S. population is likely to rely increasingly on medications of all sorts. Then, he points out, when the economic recovery materializes, rising incomes in the U.S. will help as well since people tend to spend a larger portion of their money on medicines as their economic status rises.

"We have a field of dreams ahead for the pharmaceutical and biotech industries," says Isaly. "The technology is advancing at a rapid pace, and new discoveries to either treat things better or cheaper are coming in droves. It's a situation where if it's indeed discovered, the people will come." Anderson teaches journalism at the City University of New York. Follow his Mutual Fund Maven column, only on BW Online


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