December 1, 2000

What's Up, Doc?

Faraz Naqvi, Manager and M.D., uses his varied exp

Unless you hold a degree in molecular biology or consider a proteomics textbook light weekend reading, investing in a biotechnology fund requires a leap of faith. "It's so easy to snow people who don't understand technology," says Faraz Naqvi. "As a fund manager, one of my tasks is to develop a sense of faith and trust between myself and my shareholders. They have to trust that I completely understand two areas: the incredibly complicated field of biotechnology, and the art of picking stocks."

Naqvi's background, which includes training in both economics and medicine, certainly inspires this trust. His parents came to the U.S. from India before he was born. His father is a professor of physics and his mother is a professor of mathematics. After completing undergraduate and master's degrees in economics, he went to medical school--Harvard Medical School, no less--and then completed a residency in radiology at the University of California at San Francisco. But Naqvi soon found the investment world more alluring than medicine. After medical school he took a job as a biotechnology analyst at McKinsey & Co.

"I thought McKinsey might be a horrible mistake and that I would have to go crawling back to medicine," Naqvi says. "But five minutes after walking into the place, I knew I had made the right move. The people were smart--thinking and problem-solving on their feet. Medicine by comparison involved memorization and always doing things the same way. Being a doctor today, with the way managed care is structured, is like taking a job with a big corporation as an administrator. I went into the financial world and never looked back."

Today, Naqvi is co-manager of Dresdner RCM Biotechnology Fund. The fund, with a 112% return year-to-date as of November 1 and a one-year return of 209%, has become wildly popular among investors. At the beginning of 2000, the fund had net assets of just $14 million. In just 10 months that figure has grown to nearly $1 billion. It ranks first among the biotech funds ranked by Morningstar.

This success has made Naqvi a bit uncomfortable. As part of his effort to inspire trust, he warns investors not to become infatuated with biotech. The best way to invest in the sector, he says, is to find a fund manager with the education and understanding to predict major developments and breakthroughs ahead of time.

"The biotech sector is up more than 60% so far this year while the tech sector is down nearly 3%," he says. "Biotech has become Wall Street's newest darling. But if you don't know how to play this sector, your darling will give you a black eye. Find a manager you trust, and stick with it."

Naqvi's strategy has been to play the rhythms of the biotech sector. He jumps into the riskier, cutting-edge biotech stocks when he believes events will start them on a run, and sells when he believes profit-taking is about to begin. But the majority of the 80 stocks in the fund are stable healthcare companies with strong earnings and solid pipelines of products. It's a balancing act that he has brought to a high art.

What is the most extraordinary recent breakthrough in the biotech field? It would have to be the area of monoclonal antibodies, which could lead to enormous breakthroughs in fighting disease. With this technology, you can construct an antibody to act like a magic bullet. Doctors can aim the antibodies right at the specific infection or tumor they want to attack with incredible precision.

How does this technology work? If you have an infection, it means an army of foreign cells have invaded your body. Your immune system will send out a defending army of antibodies to find these cells. They do this by attaching themselves to the invading cells. This attracts white blood cells, which attack and destroy the foreign cells.

The problem is that the antibodies do not recognize some diseases. They see cancer cells, for example, not as a foreign enemy, but as a natural part of the body. The antibodies don't initiate a defensive response, which is one of the reasons cancer is so hard to treat.

But thanks to genomics research, we can discover the shape of some cancer cells. Then we can manufacture, or clone, an antibody that does recognize the cancer cells as a threat. Someday, scientists will literally construct an antibody for a specific disease. The cloned antibody will attach itself to cancer-causing cells and initiate the immune response that fights the disease.

Are any of the biotech companies close to cloning an antibody that will fight cancer? There're not close, no. There's a long way to go. But the possibility of being able to fight cancer this way in the future is breathtaking. The biggest scientific breakthrough of all time would be finding the basis of replication of cancer cells. There are probably just a few genes responsible for cancer. If these genes could be identified, that would be incredible. Bristol Myers and Genentech are hot on this trail. It's also possible that, thanks to the scientists who deciphered the genetic code for an entire human chromosome last summer, we might develop drugs to fight schizophrenia, heart disease, AIDS, and many others.

Some biotech companies have already cloned antibodies to fight lesser diseases. Medimmune, for example, has created a monoclonal antibody that fights RFB, a viral infection that often kills premature babies. You can't fight this virus with antibiotics. This new antibody is the only weapon we have against RFB, and it's saving the lives of a huge number of neonates right now. As a bonus, it has also been found to prevent the onset of childhood asthma.

Dresdner RCM Biotechnology
Dresdner RCM Global Investors, LLC

4 Embarcadero Center

San Francisco, California 94111


Ticker: DRBNX

Portfolio manager: Naqvi/Dauchot

Manager's tenure: 1 year

Fund started: 1997

Minimum initial investment: $5,000

Load (front-end): 0%

12(b)-1 fee: 0.25%

Net assets: $961.4 million

Dist. yield (trailing 12 months): 0%

P/E ratio: 51.4

P/B ratio: 16.8

Median market cap: $4.0 billion

Expense ratio: 1.50%

Turnover: 431%

3-year alpha: N/A

3-year beta: N/A

3-year r-squared: N/A

3-year standard deviation: N/A

1999: 111.40%
1998: 17.76%
1997: N/A
1996: N/A
1995: N/A
12-month (annualized): 218.01%
3-year (annualized): N/A
5-year (annualized): N/A
Top Five Holdings
Amgen: 5.0%
Genentech: 3.5%
Medimmune: 3.4%
Waters Corp: 3.0%
Millennium Pharm.: 3.0%
Equity Allocation
As reported in the November issue of Morningstar's Principia Pro.

Annualized returns are through October 31, 2000.

Are you equally as excited by the field of proteomics? Proteomics is remarkable, but it's in an early stage of development. It's an extension of the genomics area of biotech. Genomics involves the study of the human gene and the DNA within the gene. The theory is that if you can identify a gene that causes a disease, you can produce a compound that will switch off the gene, doing away with the disease.

Proteomics, on the other hand, is the study of the proteins and amino acids inside genes and how they could be related to disease. For example, it's been found that the genes of people who suffer from sickle cell anemia have one amino acid that other people do not have. The theory is that we can develop a wide variety of artificial proteins or amino acids that would replace the gene that causes sickle cell anemia, thus eliminating the disease from the body.

This science is developing rapidly, but we probably will not see positive results for a good five to seven years. Monoclonal antibody technology, however, is helping people right now, so I'm more excited about monoclonal antibodies.

Does the speed at which the different technologies are developing affect your investment decisions? Are you investing heavily in the monoclonal antibody companies, and putting the proteomics companies on the back burner? Yes, there is a timing issue involved in the way I buy stocks. This summer, for example, when everybody was excited about the mapping of the human genome, we made big investments in the genomics sector. We knew that a lot of money was going to come flooding into genomics, and we loaded up on the pure genomics plays. We rode those stocks through the Fall, and then trimmed back and took profits.

We're buying some proteomics now. When the fire is lit beneath the proteomics sector, we will take bigger positions, ride them up, and then trim back and take profits, just like we did with the genomics companies. Taking profits reduces some of the risk inherent in this sector.

What genomics companies did you buy? We bought CuraGen, Celera Genomics, Millennium Pharmaceuticals, and Human Genome Sciences.

So, in a sense, you are trading these stocks, getting in and out opportunistically during the year? Yes, but we held on to Millennium and Human Genome, because they are more than just pure play genomics companies. We believe they have a lot of substance for the long term.

Critics of the biotech sector say while it's possible to map genes that cause disease, it might be impossible to come up with the drugs that turn these genes off. Do you agree? No. The ability to identify and turn off a disease-causing gene is based on a science called combinatorial chemistry. This involves matching the shape of chemical compounds with the shape of disease-causing genes. The compound, or drug, is then used to fight the disease. Scientists have already identified millions and millions of new chemical compounds. I don't think it will be impossible to find compounds that fight diseases.

What is the sector breakdown of the fund? We have 60 names, and less than 10% of them are genomics companies. This is because we've taken profits in these stocks. More than 75% of the fund is invested in straight biotech companies that actually have earnings and a strong product line, such as Amgen, Genentech, Medimmune, and Idec Pharmaceutical. They are not genomics companies. We also have companies that have a good chance of cutting deals with other, larger biotech or pharmaceutical companies. If they occur, these deals will greatly increase the value of these companies. They include Protein Design Labs, Abgenix, and Deltagen.

Is your small investment in genomics a sign that you have little faith in these stocks? No, it's a sign that now is not the right time to own them. As I said earlier, there is a pattern of rallies and profit-taking in this sector. We will reinvest in these companies after the profit-taking is over and they are set to rally again.

Where are we right now in this rally and sell-off pattern? The biotech sector is driven in part by the release of clinical data to analysts and the media. We are right in the middle of the period in which this data is released. If the data is good, the analysts get excited and start recommending stocks, which drives the whole sector up.

I think we are going to see a lot of profit-taking toward the end of this year, after the rally caused by the data releases drives prices upward. Then, when the sell-off is over, the sector will move up again, probably in the spring of next year.

Can you tell us which of these companies might have spectacular news, causing its stock price to go up substantially? Sure. I think Deltagen is going to cut some really big deals with pharmaceutical companies. Human Genome Sciences is also going to present clinical data on their initial pharmaceutical products that will excite the market. All of this will happen over the next few months.

Protein Design Labs has become an investor favorite. What do you like about this company? They have great technology, absolutely solid technology. They are working in the monoclonal antibody area, except they are trying to find a way to make mice produce human monoclonal antibodies. This could be a major breakthrough.

Amgen is your top holding. If you look at Amgen's chart, it seems like a stock that will tread water for some time. It has dropped below its moving averages at times, daily trading volume is low, and it's well off its 52-week high. What's your outlook? I agree that Amgen will be range-bound for some time. The problem is a patent lawsuit that is holding down the stock price. It could remain like this until the suit is settled, and it's hard to say when the settlement will come. But with that said, there is a nice way to ride this stock as it trades up and down. It has a floor of about 55, but it rises up to the high 60s and then back down to 55. You can try to catch it low and ride it up to the 60s and make some money.

Does it bother you that investors seem to be using the biotech sector as a safe haven from the crumbling tech sector? They seem to think they are going to get the same double- and triple-digit returns in biotech this year that they had in tech last year. It does bother me, yes. I can understand the rationale for being in biotech. And biotech funds have turned in solid returns. I can't argue that companies that come up with cures for diseases are not potentially great investments. But this is going to happen over the long term, it's not going to happen tomorrow. The biotech sector is volatile, and that's something that investors should take seriously.

Are you concerned about the high valuations of some biotech companies? They scare the heck out of me. Many biotechs are not going to produce the earnings that justify these valuations, which is another reason that investors should not see this sector as a safe haven from techs. We protect the fund from these high valuations by owning, in addition to the genomics and proteomics companies, the safer companies, like Amgen, that can support their high valuations. We have to be defensive to protect the fund.

Who is the perfect shareholder for a biotech fund? I think every investor should have some biotech. Over the long haul, they could be the best fund investment you ever made. But investors should be reasonable. Because the sector is volatile, I recommend that people limit their investments to 5% of their portfolio.

These stocks can go up 20 and 30 points in a day, and they can come down an equal amount the next day. Investors should understand that a biotech fund can be a bumpy ride.

What's your biggest fear for the biotech sector? My biggest fear is government regulation. The advances in biotech have happened so quickly that the government does not yet fully understand them. My fear is that the government will decide that it has to regulate, in a random way, the way the industry does business.

Give us an example of what could happen under government regulation. Protein Design Labs is trying to develop human monoclonal antibodies in mice. The technology they use to do this is their intellectual property. But it's possible the government could step in and say no one company should have this intellectual property. This would essentially destroy the company.

Do you believe this could happen? It's possible, the same as it's possible that the government might some day tax commerce on the Internet. It depends on how enlightened our leaders are. If they come up to speed on technology and understand how wonderful it is, then they might leave us alone.

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