Big pharma is cheap and out of fashion. But it could prove very profitable over the next ten years, says Bengt Saelensminde. Here, he explains why, and picks the best way to invest in the sector.
As ever, Mr Market keeps toying with us. With the FTSE yo-yoing around 6000, it looks like a tug-of-war between a negative economy on the one side, versus Mervyn King and his free money on the other. This could go either way.
One thing is for certain though - after the run up we've seen over the last year, you would be mad not to take out some kind of insurance against a downswing.
And that's what I want to talk about - how you could limit your downside by investing in a sector which I believe will be a very happy hunting ground over the next decade.
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I think big pharmaceuticals offer the best kind of insurance for your portfolio right now. They produce goods which are essential to modern life and they throw off plenty of cash.
And let's face it, the sector is not exactly in fashion at the moment. If the markets hit the skids, pharma has less distance to fall.
It's also an incredibly exciting time in the industry, with recent developments in biotech and gene sequencing hinting at a golden era for drug development.
With cheap gene sequencing, for example, demand for drugs that stave off hereditary diseases could explode - especially as governments seek to vaccinate children. The market research firm Evaluate Pharma projects that biologics (genetically engineered drugs) will account for 50% of the top 100 drugs in 2014, compared with 28% in 2008.
In fact, I am expecting to see a major re-rating of pharmaceuticals as investors wake up to the huge promise of some of these drugs. So here's how I think we should invest.
Build your position in layers
I focus on investment themes. And right now pharma is my latest squeeze. When I start to build exposure to a new theme it's usually structured in three distinct layers:
The base (50%) - through managed funds, usually investment trusts, or ETFs where I get the benefit of diversification, without expensive fees!
The middle (30%) - large stocks hand chosen. Here I get the benefit of no management fees and the dividend income can be re-invested as I wish
The top (20%) - made up of small and speculative stocks. Here I get excitement and the potential for stellar returns
It can take a long time to build this structure. It involves gradually shifting money from sectors that are maturing into the latest themes. But this is how I plan to start...
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Make this investment trust part of your pharma base
Today I want to introduce you to the Worldwide Healthcare Trust PLC (LSE:WWH). It's an investment trust - so you can buy it through your normal broker, just like buying any other share. The annual management fees on investment trusts also tend to be lower than unit trusts (or OEICs) and often they trade at a discount to the value of shares they hold.
Today, WWH trades at a discount of 7% to the assets it holds -you won't get that with a unit trust. The biggest holdings in the trust include drug titans Novartis (6.1%), Merck (5.8%)and Roche (5.7%). But it's also heavily invested in biotech through Genzyme and Amgen.
Investment strategy is managed by a group called Orbimed. Before choosing this fund I had a good read-around the industry, and Orbimed's name kept cropping up. They appear to be an important research unit for the industry.
And as the fund manager for WWH, they seem to have backed up their reputation. Here are the figures for how they grew NAV over the last five years to December 31st 2010 (as detailed in the Frostow Capital WWH factsheet).
Source: NAV (total return; fully diluted) & Share Price - Morningstar. Index - Thomson Reuters & Bloomberg. Past performance is not a guide to future performance.
*With effect from 1 October 2010, the performance of the Company is measured against the MSCI World Health Care Index on a total return, sterling adjusted basis. Prior to 1 October 2010, performance was measured against the Datastream World Pharmaceutical & Biotechnology Index (total return, sterling adjusted).
2010 was a great year for the fund, NAV grew by double the index! And while they have underperformed in two of the last five years, they have certainly earned their management fees over that period.
The overall fund fees by the way come in around 1% a year (though it varies as there is a performance fee too), which seems very reasonable.
Here are the vitals on this trust:
Ticker: WWH.LN
Price: 697p
52 Week High/Low: 709p/613p
Net Asset Value: 755.8p
Management Fee: 0.65%
Total Expense Ratio: 1.1%
I'm very happy to build my pharma base with these boys. And I hope you share my enthusiasm. Because I really do think that pharmaceuticals should be a major part of your portfolio. Yes they are out of fashion. And yes they are tainted by the prospect of patents expiring on blockbuster drugs.
But I think that will change as biotech, stem cell and genomic breakthroughs continue to hit the headlines. And more importantly, they make a very sound investment case right now. Cheap, with shed-loads of cash and a captive market of ageing Westerners - there is a lot to like here.
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Theo Casey. The Right Side is issued by MoneyWeek Ltd. MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798.https://www.fsa.gov.uk/register/home.do
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Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.
He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.
Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.
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