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Online Extra: Biotech as "a Defensive Sector"


In a dismal quarter for most investors, biotechnology funds generally did well from January to March this year. That's because demand for biotech products -- in particular, medicines -- has continued to grow faster than the economy as a whole. One of the funds that outperformed was the $830 million Biotech P fund from Swiss private bank Pictet. It showed a 2.68% return on the quarter, putting it among the world's 10 best-performing offshore funds. Michael Sj?str?m, who manages the fund, discussed his investment strategy with BusinessWeek European Economics Correspondent David Fairlamb. Following are edited excerpts of their conversation:

Q: Why is biotech doing better than other sectors?

A: Demand for biotech products is strong and will become stronger as populations age and medical needs grow. Over the past 25 years, we have seen the emergence of an industry based on molecular biology, which is now able to deliver real medical results. If you can deliver innovative drugs to the market, people will buy them no matter what's happening in the rest of the economy. So this is, in effect, a defensive sector.

The overall economy is relatively unimportant for this sector. Just two things associated with the overall economy are of concern: The high level of uncertainty caused by low economic growth means that it's often tough for new companies to get early-stage financing because investors are generally nervous. Also, there's a general aversion to equities right now, and that could affect stocks, even in this sector.

Q: How big is the sector now?

A: Over the past five years, the market capitalization of the sector as a whole has grown from $10 billion to $25 billion. There are now many more companies to invest in than there used to be. The biotech index as a whole is up 17% over the past five years. By contrast, stock markets are down 16% on average.

Q: But biotech didn't do well last year. What explains its recovery over the past quarter?

A: Many of the regulatory problems in the U.S. that hurt the industry last year have now been resolved. In the first half of 2002, the sector was held back because it was taking longer than previously to get new products approved -- the Federal Food & Drug Administration in the U.S. [where most biotech products are developed] was suffering from a shortage of funds and weak leadership. With so many new products being produced, the regulators couldn't keep up. Those problems have now been overcome, and applications are being processed much faster.

The sector was also hit last year by the insider-trading scandal at ImClone Systems [a young U.S. biotech company at the forefront in developing anticancer drugs]. That scared everyone off...and disappointed everyone with the end product. Luckily, there has not been a repeat of that incident, and investors in the sector have regained their nerve.

At the same time, a large number of new products are due to be launched this year and next. That's drawing more investors in and driving up share values. If you add all those facts together, you have the environment that explains the reasonably good performance.

Q: What do you look for in the companies you invest in?

A: Our approach over the long run -- and we have been running the fund for almost 10 years -- is to focus consistently on fundamentals: The science, the management, and the financial side of the companies.

You have to be selective in this business because the failure rate is so high. Selectivity has a lot to do with our good investment results. In the last two to two-and-a-half years, we have particularly focused our efforts on commercial- and precommercial-stage companies, as opposed to platform-technology companies. The former groups have products on the market or in the later stages of clinical development.

Owning the rights to a product is where you make money in this business, so it's important to be in that position. If all you have to offer is a set of technologies without products, you're not necessarily going to shine. If you want to point out one key aspect that has made the Pictet fund a good performer over time, it's the way we focus on companies with products in the later stage of development.

Q: Which companies do you favour?

A: One is Gilead Sciences, which was one of the very best performers last quarter -- and indeed last year. It shone because of the strength of sales of Viread, its drug for the treatment of HIV infections. Gilead also made a very clever acquisition of Triangle Pharmaceuticals, which is also active in the HIV field. Among the other high-flyers, CuraGen, a genomics-focused drug company, and Abgenics and Medarex, which specialize in antibody developments.

Q: All those are U.S. companies. Do you have any from Europe on your list?

A: In Germany, you have GPC Biotech and Morphosis. Both are trying to transform themselves into pipeline companies, with a lot of products coming through.


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