Quick Take: The $475.9-million Franklin Biotechnology Discovery Fund (FBDIX) plummeted 42.5% in calendar 2002, along with the biotech sector as a whole. But for the five-year period ended December 2002, the fund posted an average annualized return of 8.0%, versus 4.3% for the handful of biotech funds in our universe with five years of operating history. The biotech mandate, however, makes this portfolio very risky. The fund’s standard deviation, a measure of volatility, is much higher than that of funds invested broadly in health care.
Managed by Evan McCulloch since its September 1997 inception, this is one of the longest-running ‘pure’ biotech portfolios around. Since it gives investors a strong dose of a notoriously volatile sector, the fund’s yearly returns have varied wildly. After skyrocketing 97.9% in 1999, it rose another 46.6% the following year, before dropping 20.5% in 2001. Such variance is to be expected from an industry that is still enduring growing pains. Most biotechs are not yet profitable, and bringing a drug to market is a long, arduous, risky and expensive process. However promising biotech’s future, such a portfolio is not for the faint of heart.
The Full Interview:
S&P: The NASDAQ Biotech Index plunged 45.3% in 2002. Why did biotechs perform so poorly?
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McCULLOCH: There were several factors that contributed to the sector’s weak performance. The bulk of these events occurred in the first and second quarters of the year. We witnessed many company-specific disappointments — so many, in fact, that this became a `sector trend’ unto itself.
S&P: What kinds of disappointments precisely?
McCULLOCH: There were a number of negative FDA-driven events, i.e., delays or outright rejections of new products. There were also numerous drugs that failed in clinical trials. Some companies faced manufacturing problems. The sector suffered as a whole due to the scandals at Elan Corp. plc (ELN) and ImClone Systems (IMCL).
S&P: What are your largest individual holdings?
McCULLOCH: Out of 49 positions as of Dec. 31, 2002, our top ten holdings were Amgen Inc. (AMGN), 12.6%; MedImmune Inc. (MEDI), 7.7%; IDEC Pharmaceuticals Corp. (IDPH), 5.6%; Gilead Sciences Inc. (GILD), 5.0%; Genzyme Corp-General Division (GENZ), 4.3%; Biogen Inc. (BGEN), 3.3%; Serono SA, 3.1%; Millennium Pharmaceuticals Inc. (MLNM), 2.7%; NPS Pharmaceuticals Inc. (NPSP), 2.6%; and Neurocrine Biosciences (NBIX), 2.6%.
S&P: Given that Bristol-Myers Squibb Co. (BMY) was badly hurt by the Erbitux/ImClone fiasco, did it dissuade big drug companies from entering into partnership arrangements with biotech firms?
McCULLOCH: I think initially big pharma did indeed step back from entering into deals with biotechs, but this hesitation was short-lived. In fact, just recently, we saw Pfizer Inc. (PFE) signing a couple of huge deals, including a $400-million agreement with Neurocrine Biosciences (NBIX) to develop Indiplon, Neurocrine’s insomnia drug.
We expect to see many more similar arrangements between big pharma and biotechs. Recognizing that product pipelines at pharmaceutical companies are still fairly weak, we think the terms of these partnership agreements will become increasingly lucrative for biotech firms.
S&P: Biotech stocks typically have strong fourth quarters, as they did in 2002. Why is this?
McCULLOCH: In the fourth quarter we have a plethora of major medical conferences and investor forums. The biotech sector is very ‘catalyst-driven.’
S&P: A new FDA Commissioner was appointed in October. Will this lead to an acceleration of drug approvals in 2003?
McCULLOCH: I think we will see an increase in drug applications and approvals this year, but this is partially because several prominent new drugs were delayed in 2002. [According to the Biotechnology Industry Organization, 20 new biotech and biotech-related drugs were approved by the FDA, which also cleared 15 new indications for previously approved products in 2002].