Biotech gems: a needle in a Heystek

Biotechnology sits at the very edge of the scientific envelope and backing this kind of research and development with your own money is not for the fainthearted.

Biotech, which can be defined as manipulating or recreating living organisms with the aim of defeating illness and disease, is true laboratory experimentation and can be hit-and-miss - a good concept may not always deliver a workable medical solution. What investors in this industry hope for is a company that can get through the research and clinical trials and emerge with a safe and effective product approved by the relevant health authorities.

Sasha Naryshkine of asset managers Vestact said: "Every now and then someone does come up with a home run that seems to buoy everybody, but as a sector it's been a horrible investment, prone to wild swings."

But others say that biotech is promising for investors with an appetite for risk. Global investment house Franklin Templeton's biotech fund announced a soft close in the middle of last year, meaning new investors could not get on board but existing investors could add more money to the fund.

In an investment note from 2014, Franklin Templeton said it expected its major pharmaceutical holdings to consolidate value and maintained a posi-tive outlook for its less mature holdings in the biotech sector, where it said long-term growth appeared underpriced.

At the time, local asset manager Brenthurst Wealth, with Magnus Heystek at the helm, recommended that investors who could handle such an aggressive fund - ideally high-net-worth individuals who could part with at least R200000 of spare capital - should invest with a long-term timeframe.

A long-term position is key, given that research and development windows can be longer than a decade and the biotech index has tended to display twice the volatility of any other. This year Brenthurst Wealth is saying much the same, based on returns over the past two years from companies including Gilead, Celgene and Regeron.

Outlining its favourable view on biotech, Heystek's company said annual returns of better than 60% were possible in a market hit by a lower global oil price and the expectation of lower economic growth this year.

"The biotechnology industry has blown many other sectors out of the water in the past two years and continues to grow at a phenomenal pace as the executives and researchers at these companies push the frontiers of medical science," Brenthurst Wealth said.

"Working on cures for cancers, diabetes, Alzheimer's and Parkinson's, as well as new products to slow the ageing process, has excited the medical fraternity and delivered exceptional results for investors."

The company said that, in 2013, the Franklin Biotechnology Discovery Fund had delivered 113%, with an annual average return over a three-year period of 59%, and last year it delivered 34.7%, well above the returns achieved by many other sectors.

The asset manager cited Marketwatch.com data showing the top-performing stock on the S&P 500 last year was Forest Laboratories, a New York-based pharmaceutical company which delivered a return of 60%.

Heystek said biotech had been an "important selection for our clients' portfolios over the past four years, adding substantially to performance". He cautioned that it was still best to engage an investment professional before making such an investment decision.

But Naryshkine recalled that in April last year the Nasdaq biotech index - which includes Amgen, Celgene, Biogen and Gilead - tumbled 5.6% in one evening, went down 15% in the previous month, and was 7% down over three months. A note from Vestact at the time said: "The earnings expectations are very lofty and the prices have been primed for perfection. An earnings stumble would be a disaster."

By comparison, Naryshkine said Johnson & Johnson recently released its results which showed that the company spent 11.4% of annual revenue - more than $74-billion (R845-billion) - on research and development.

"That's more than some of these biotech companies as a collective have had as revenue in their 15 years of existence," he said.

The volatility is not for everyone, and there is scant information on which to base stock picks, since many biotech players do not yet have much revenue.

"Of 192 biotherapeutic drugs, I can find maybe 10 companies with a proper multiple. Out of all these, there's only one company over half-a-billion dollars in size that makes money - Taro Industries from Israel - and it's not even at the cutting-edge end of the market," Naryshkine said.

The Nasdaq biotech index is up 60% over the last six months but Naryshkine is not keen on it. "It's almost impossible to look at the fundamentals. It's just too difficult. Even though Johnson & Johnson and Pfizer look unexciting, they're more mature, already spend a lot on research and development, and Pfizer trades on a 3.5% dividend yield and a 20-times price-to-earnings ratio.

"We should remember Amgen was once a penny stock and as a business it has matured. But if you're looking to pick individual stocks from 150 to find the next thousand-bagger, I'd say there are better ways to spend your time. I'd recommend maybe 2% biotech for your portfolio, and if you have a pacemaker, avoid it," Naryshkine said.