Behind the trust: International Biotechnology Trust plc
Biotech companies stand to inject high returns and positive social impact into an investor’s portfolio and International Biotechnology Trust has an impressive track record of doing this with lower volatility than the index (NASDAQ Biotechnology Index), while paying a healthy dividend yield.
Looking to invest in innovation? Then look no further than the biotechnology sector. An allocation to biotech stocks allows investors to tap into a dynamic area of investment markets that addresses high, unmet medical needs and offers the opportunity for good returns and the creation of a positive social impact.
The sector has been ripe with innovation in recent decades. A deeper understanding of biology has paved the way for treatments such as gene, cell and RNA therapies. The discovery and evolution of these platform technologies is paving the way for treatments for a broad spectrum of diseases hitherto considered untreatable.
Artificial intelligence (AI) is also transforming the sector by enabling faster and more accurate analysis of complex biological data. The integration of AI in biotechnology creates many benefits, from accelerating drug discovery to advancing personalised medicine.
Another key attraction of biotech investing is its status as a structural growth sector. Demand for healthcare is forecasted to grow, driven by an ageing global population and rising incomes across the developing world. This potentially gives the biotechnology sector a long runway of growth ahead.
All of this said, the sector is notoriously volatile. This stems from two main factors. Firstly, the success of a single biotech company often hinges on a binary outcome for one potential drug. Either clinical trials show the drug to be safe and effective – or they do not. Another possible outcome is that the trial succeeds but the drug doesn’t improve an ever-higher efficacy or safety bar, in which case the investment is deemed a commercial failure.
Cyclical valuation drivers exacerbate this volatility. As an investment, biotechnology commonly moves in and out of favour depending on the macroeconomic outlook. Investors tend to invest in the sector when the economy is booming and sentiment is ‘risk on’ and divest in favour of more defensive assets during tougher times when sentiment is ‘risk off’.
For those investors keen to capitalise on the growth potential of the sector without bearing the full brunt of the volatility inherent in the sector, International Biotechnology Trust (IBT) has achieved exactly that. Let’s take a closer look at the trust and what makes it a worthy addition to an investor’s portfolio today.
What does the trust do?
International Biotechnology Trust seeks to achieve long-term capital growth by investing primarily in biotech and other life sciences companies that possess the potential for high growth. The portfolio is mainly comprised of quoted companies but also has 5-15% exposure to unquoted companies and venture funds.
Over their many years managing the trust, the managers have developed a rigorous investment process that aims to outperform the index, while keeping volatility below that of the index. It is this keen focus on risk management that sets the trust apart from competitors and has allowed it to outperform both the Nasdaq Biotechnology Index and its peer group over both shorter and longer timeframes.
Unusually for an investment strategy that is focused on growth, the trust also offers a high and sustainable source of income. That is because it offers a dividend equivalent to 4% of the closing net asset value (NAV) at the end of each financial year. This is paid in two equal instalments – at the end of January and August the following year.
How does it do it?
The trust invests across the entire spectrum of biotech companies and has exposure to around 100 quoted and unquoted companies. Holdings are well diversified by therapeutic area, company size and development stage.
In selecting stocks for the portfolio, co-lead managers Ailsa Craig and Marek Poszepczynski have a list of attributes they look for – and red flags to avoid. Key criteria for inclusion in the portfolio include excellent management teams, innovative products, robust financials and strong potential for outperformance.
On the flipside, they tend to avoid companies that may struggle to access refinancing. Red flags include limited cash, sparse management experience and expensive financing methods.
They also assess the nature of trials carefully. They prefer trials in which neither the participants nor the clinicians know which patients have the tested treatment and which the placebo. Likewise, trial re-designs that diverge from previous clinical phases and selective ‘cherry-picked’ statistics tend to raise red flags.
Selecting companies with the highest chances of success is one aspect of the strategy; keeping a lid on volatility is another. For Craig and Poszepczynski, the key to reducing volatility in a portfolio of biotech stocks is knowing where we are in the biotechnology investment cycle at a given point and positioning the portfolio to benefit.
They use their experience and expertise to exploit the inevitable shifts in valuations at different stages of the cycle. They view this in five stages:
Stage 1: Despair – company values are depressed
Stage 2: Recovery – merger and acquisition (M&A) activity reignites and valuations start to recover
Stage 3: Equilibrium – fair value and growth return to the sector, the initial public offering (IPO) window opens and the sector attracts an influx of capital and steady stream of M&A activity
Stage 4: Euphoria – values become hyped and the IPO market booms
Stage 5: Correction – M&A and IPOs dry up and investors move into ‘risk off’ mode
Source: Schroders, 2023
The Covid-19 pandemic, and the success of the associated vaccines and treatments, exaggerated the most recent loop around this cycle. The intense focus on the biotech sector spurred retail investor trading during lockdown and propelled the sector into euphoria. However, the subsequent correction in spring 2021 was equally as sharp and led to negative returns for the sector each year since then.
By mid-2023, the managers reckoned the market was on the cusp between stage two – recovery, and stage three – equilibrium. Valuations had stabilised and IPOs and M&A had returned as larger, cash-rich companies tried to fill the imminent voids in sales created by their lead products approaching the end of their patent periods towards the end of this decade.
Another way in which the trust is very actively managed relates to the trading of shares around impending binary events. In a bid to preserve capital, the managers reduce exposure to a specific company as it approaches trial results, netting the uplift in valuation ahead of the event as the market typically prices in good news. If the news is positive, they may choose to rebuild the position. If the news is negative, they have sheltered investors from the selloff that invariably follows.
In November 2023, the management of the trust moved to Schroders from SV Health Managers following a beauty parade of potential suitors. Schroders was chosen on the strength of its investment trust capabilities and depth of its resources.
Importantly, both co-managers moved with the trust and there has been no change to the way the portfolio is managed. The sub-portfolio of unquoted investments continues to be overseen by Kate Bingham, the managing partner at SV Health who rose to prominence during the Covid-19 pandemic as head of the UK government’s vaccine taskforce.
There are many compelling reasons to invest in International Biotechnology Trust. Here are ten of them:
1. Growth potential
Driven by innovation and ever-growing demand for healthcare, the long-term growth potential of the biotech sector is massive. Most of IBT’s portfolio is invested in US-listed biotech stocks, which are at the heart of global innovation, have superior access to funding from the stock market and are subject to internationally respected regulatory scrutiny.
The managers are particularly excited about new technologies emerging in oncology, mental health and rare diseases. These treatments address high unmet medical needs and therefore have better pricing power than other areas.
2. Differentiated source of income
With a dividend of 4% of NAV, the trust offers a highly differentiated source of income for income hungry investors who would not otherwise have much opportunity to obtain exposure to this part of the market.
Paying dividends from capital makes the income stream more secure than relying on dividends received from underlying companies to fund a yield.
3. Balance of companies
The biotech sector is diverse, comprising mature multi-billion dollar companies that have been in existence for decades as well as micro caps engaged in early-stage laboratory work. IBT invests across this spectrum with individual companies rarely accounting for more than 8% of the portfolio.
The portfolio typically has two-thirds of assets in ‘profitable’ and ‘revenue growth’ companies (those with an approved drug selling on the market) and one-third in ‘early stage’ companies. The latter boast the most exciting cutting-edge therapies with the potential to form the next generation of medicine but also carry higher risk of failure.
In allocating to higher-risk companies, the managers tend to build a small ‘toe in the water’ position (typically less than 1%), which they add to incrementally as the company proves itself and their relationship with the management team deepens.
4. Intelligent allocation
The managers take a bottom-up approach but with an important top-down overlay, tilting allocations depending on how they view the biotechnology investment cycle. The portfolio can be tilted away from higher-risk companies towards more mature cash generative companies when the market looks to be correcting, and vice versa when the prospects for the market look positive.
During the second half of 2022 and 2023, the managers increased exposure to smaller, earlier stage businesses as valuations became more attractive. “Many of these companies are trading at or below cash values, yet this sort of risk-off environment can still yield ground-breaking innovation and tremendous growth,” says Craig.
5. Mitigating volatility from binary events
The managers don’t try to predict the success or otherwise of binary events. By following companies closely, they know when to expect clinical trial data readouts or news from the regulator on approvals. Reducing exposure to a company as it approaches this type of binary event helps to preserve capital and mitigate portfolio volatility.
Take for example uniQure, a rare disease gene therapy company. The managers reduced the holding from a top ten position to just 0.1% of the portfolio ahead of a readout of the trial for its secondary product to treat Huntington’s disease. The news was interpreted as negative by the market and the stock fell by around 40%.
6. Active use of gearing
The managers also seek to mitigate downside risks and enhance returns by actively adjusting the portfolio’s gearing (investing borrowed money alongside shareholders’ capital). Adding to gearing at times of high conviction has the potential to enhance returns for shareholders. Conversely, reducing gearing in a downturn may also help to stem losses.
7. Lower volatility
Thanks to the many risk management tools outlined above, not only has the trust outperformed the index and peers over the five years to IBT’s most recent year-end in August 2023, but it has done so with lower volatility.
8. Strength of management
The managers have been involved with the trust for years – Craig since 2006 and Poszepczynski since 2014 and became co-lead managers in March 2021.
They bring a combination of scientific, industry and financial experience to the team. Understanding the science is key and Craig and Poszepczynski are scientifically trained. Poszepczynski has industry knowledge having worked for and started biotech companies himself. Bingham who leads the SV team managing the unquoted portfolio has 30 years’ experience in biotech investing.
9. Proactive engagement
IBT is a responsible steward of capital. Every six months, the managers formally assess the ESG metrics of the trust’s top ten holdings, the results of which are published in its interim and annual reports. The managers actively engage and follow up on any ESG issues.
Very large funds with a small number of positions have less liquidity. Running a mid-sized fund with a broad number of investments allows the managers of IBT to invest in smaller companies and actively manage the portfolio to the potential long-term benefit of shareholders and society.
Fund Risk Considerations - International Biotechnology Trust plc
Capital risk / distribution policy: As the Company intends to pay dividends regardless of its performance, a dividend may represent a return of part of the amount you invested.
Concentration risk: The Company's investments may be concentrated in a limited number of geographical regions, industry sectors, markets and/or individual positions. This may result in large changes in the value of the Company, both up or down.
Currency risk: The Company may lose value as a result of movements in foreign exchange rates, otherwise known as currency rates.
Gearing risk: The Company may borrow money to make further investments, this is known as gearing. Gearing will increase returns if the value of the investments purchased increase by more than the cost of borrowing, or reduce returns if they fail to do so. In falling markets, the whole of the value in that such investments could be lost, which would result in losses to the Company.
IBOR risk: The transition of the financial markets away from the use of interbank offered rates (IBORs) to alternative reference interest rates may impact the valuation of certain holdings and disrupt liquidity in certain instruments. This may impact the investment performance of the Company.
Liquidity risk: The price of shares in the Company is determined by market supply and demand, and this may be different to the net asset value of the Company. In difficult market conditions, investors may not be able to find a buyer for their shares or may not get back the amount that they originally invested. Certain investments of the Company, in particular the unquoted investments, may be less liquid and more difficult to value. In difficult market conditions, the Company may not be able to sell an investment for full value or at all and this could affect performance of the Company.
Market risk: The value of investments can go up and down and an investor may not get back the amount initially invested.
Operational risk: Operational processes, including those related to the safekeeping of assets, may fail. This may result in losses to the Company.
Performance risk: Investment objectives express an intended result but there is no guarantee that such a result will be achieved. Depending on market conditions and the macro economic environment, investment objectives may become more difficult to achieve.
Share price risk: The price of shares in the Company is determined by market supply and demand, and this may be different to the net asset value of the Company. This means the price may be volatile, meaning the price may go up and down to a greater extent in response to changes in demand.
Smaller companies risk: Smaller companies generally carry greater liquidity risk than larger companies, meaning they are harder to buy and sell, and they may also fluctuate in value to a greater extent.
Valuation risk: The valuation of some investments held by the Company may be performed on a less frequent basis than the valuation of the Company itself. In addition, it may be difficult to find appropriate pricing references for these investments. This difficulty may have an impact on the valuation of the Company and could lead to more volatility in the share price of the Company, meaning the price may go up and down to a greater extent.
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