International Biotechnology Trust (IBT) has delivered a solid performance of 14.3% in NAV terms this year and grown its dividend by 4.1% in the face of difficult conditions for biotech companies.
Volatility in broader equity markets – spooked by fears of a trade war, the Brexit debacle, and tensions in the Middle East – has not helped biotech, which tends to perform poorly in ‘risk off’ environments, but IBT’s unquoted portfolio, a unique feature of the trust, has lent considerable support to NAV returns during a period when the listed portfolio has struggled.
The trust’s decision to pay out 4% of NAV annually in the form of dividends, drawn entirely from capital, continues to pan out well for investors who have seen a full year dividend of 28p in 2019, up 4.1% on last year’s payout and more than 20% higher than the dividend in 2017. In yield terms, the trust stacks up strongly even against trusts designed specifically for income investors – with a higher yield than the average trust in the UK Equity Income sector – and the trust’s discount has narrowed sharply on the back of steady demand for its shares since the income commitment was introduced.
2019 has been a bumpy ride for biotech investors with gains made in the first half lost in the autumn, before a sharp rebound in October. Healthcare is a traditional football for all candidates in the run up to a general election in the United States, so more volatility is not unlikely. The managers say prices are depressed relative to other S&P sectors, but think the fortunes of the sector could improve ahead of the US election as the market begins to realise the extent to which valuations are depressed.
In our view the biotechnology sector has significant tailwinds behind it, and this trust is well set up to benefit from them whilst avoiding the worst of the volatility which tends to torment investors in more ‘risk on’ sectors like this. The trust’s unique focus on avoiding binary risk events has helped it to avoid a number of ‘blowups’ which have affected its rivals, and its unique unquoted portfolio is already proving its worth, with an average yearly internal rate of return (IRR) of 16% despite the venture fund being only 70% invested at this stage. Expected distributions from the fund mean that IBT will only need to make limited cash contributions going forward to meet its commitment.
IBT offers a differentiated source of income, but also one that beats that available from the average trust in the UK Equity Income sector. At the same time, IBT has a strong track record of long-term capital growth.
We believe that there are two clear long-term tailwinds behind biotechnology as a profitable area for investors. Firstly, there is an element of ‘Moore’s Law’ involved; technological advances in one area enable and multiply the opportunities to develop new technology and to find applications for it in other areas. Secondly the increasing wealth, age and quality of life which are to be found in the developing world provide significant and lasting opportunities for biotech companies. Many of biotech’s products, in aging developed market populations, are much more of a must-have than the latest iPad or consumer fad.
The managers say next year’s US general election is likely to cast a pall over demand for biotech stocks, and price/earnings ratios reflect this sluggish environment. But, far from being dejected the managers see this as a significant opportunity to buy good companies at depressed valuations and expect a rebound like the one we saw after a bear market for biotech in the run-up to the 2016 US general election.
Against this backdrop we think IBT is well positioned. We particularly like its strategy of mitigating risk by diversification across sub-sectors, selecting therapeutic areas with defensive characteristics, avoiding large ‘elephants’ accounting for any more than 10% of the portfolio, and avoiding binary events (i.e. divesting stock as companies approach the announcements of the results of crucial trials, even if this means missing out on the last few yards of upside). The unquoted portfolio adds another powerful layer of differentiation and has made a valuable contribution to returns this year.
|A highly experienced manager with a proven track record of outperformance, who is supported by a strong and specialised team
||Biotech stocks could remain somewhat torpid in 2020 as the US presidential election gets underway and healthcare, as usual, becomes a topic of hot debate
|Offers a solid yield and good prospects for capital growth
||Biotech stocks tend to exaggerate volatility in other sectors, and so are vulnerable to wild swings during ‘risk off’ periods when investor sentiment is volatile
|A risk-focused investment process sees the trust divest from companies as they approach ‘binary risk events’ like drug trials, which shields it from the worst excesses of volatility