(PUB) Investing 2015

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11 Morningstar FundInvestor April 2015
Scientific breakthroughs can boost stock prices, but
they can’t immunize them from sell-offs. That’s worth
keeping in mind as biotech and pharmaceutical
stocks, spurred on by the promise of innovations in
genetic therapy, continue to boom. When markets
go south, valuations matter, and with the all-
cap Nasdaq Biotechnology Index (roughly split 80/20
between biotech and pharma) currently trading at
a trailing 12-month average price/earnings ratio
near 30 versus the Russell 3000 Growth Index’s 22,
this corner of the market could be poised to fall
further than others. The Nasdaq Biotechnology
Index’s 18.2% plunge from early March to mid-April
of 2014 was nearly 15 percentage points worse
than the Russell index’s. As biotech has enjoyed a
remarkable rally, we sought some funds with
at least a fourth of their portfolios in biotech and
pharma combined.
Among Morningstar 500 funds without a health-care
mandate, Fidelity Capital Appreciation FDCAX
leads the way. In January 2015, this fund, which
carries a Morningstar Analyst Rating of Bronze, held
a third of its assets—in a roughly 65-stock port-
folio—in biotech and pharmaceuticals. Investors
familiar with manager Fergus Shiel’s go-any-
where approach should not be surprised. With little
regard for benchmarks or style drift, he focuses on
companies with share prices poised to increase in the
next six to 12 months. The short-term focus leads
to high turnover but does not preclude doubling down
on his bets, such as adding to the fund’s position in
top holding Gilead Sciences GILD in December 2014
when concerns about a potentially cheaper alter-
native to its revolutionary hepatitis C drug caused a
share-price drop. Shiel’s willingness to dive in has
in part led the fund to underperform the Russell 1000
Growth Index in cratering markets like the 2007–09
credit crisis. But from his late October 2005 start date
through February 2015, the fund’s 9.6% annualized
gain is in line with that index and over a percentage
point better than the S&P 500, though at the cost of
greater volatility.
Moving down the market-cap spectrum, mid-cap
growth fund Eventide Gilead ETGLX at year-
end 2014 held roughly 70 stocks, 22 of which were
in biotech and pharma. They added up to 25% of
the fund’s assets, 10.7 percentage points more than
the Russell 2000 Growth Index’s. The fund’s over-
weighting is typical, which makes sense given that
comanager Finny Kuruvilla holds an M.D. from
Harvard Medical School, as well as a doctorate in
chemistry and chemical biology from Harvard Univer-
sity, not to mention an engineering and computer
sciences master’s degree from MIT. The fund’s sector
biases and its timely July 2008 start date go a
long way toward explaining how its 18.2% annualized
gain through February 2015 manages to trounce the
Russell 2000 Growth Index by 6.7 percentage points.
That record comes with a bit of an asterisk, as the
fund’s 25.6% loss in 2011’s third quarter was 3.3
percentage points worse than the index’s. For now, a
repeat of that underperformance seems unlikely.
The fund’s cash stake has surged to a since-incep-
tion high of nearly 20% of assets, up from 0% at
2012’s close.
World-stock fund Oppenheimer Global Opportuni-
ties OPGIX also has a 25% combined stake in biotech
and pharma, as of early 2015. That’s 16 and 13.4
percentage points more than the MSCI All-Country
World Index and category norm, respectively.
Nearly half of the fund’s exposure is in top holding
Nektar Therapeutics NKTR, a domestic small-cap
firm. Big sector bets and a preference for smaller-
cap firms is nothing new for longtime manager Frank
Jennings. Still, the fund’s positon in Nektar is
larger than usual, which is a concern. It suggests
Jennings’ prior attempts to reduce the fund’s vola-
tility, consistently among the category’s highest, have
come to an end. That, along with succession risk,
recently led to a downgrade in the fund’s Morningstar
Analyst Rating to Neutral from Bronze. œ
Contact Alec Lucas at
Biotech Fans Could Have a Hangover
Red Flags | Alec Lucas
What is Red Flags?
Red Flags is designed to alert
you to funds’ hidden risks. Such
risks can take many forms,
including asset bloat, the
departure of a solid manager, or
a focus on an overhyped asset
class. Not every fund featured
in Red Flags is a sell, and in fact,
some are good long-term
holdings. But investors should
be prepared for a potentially
bumpier ride in the near future.