Skip to Content
Fund Spy

Biotech Fans Could Have a Hangover

This corner of the health-care market could be poised to fall further than others.

Mentioned: , , , ,

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) recently 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 fifth of their portfolios in biotech and pharma combined.

Among funds in the Morningstar 500 without a health-care mandate,  Fidelity Capital Appreciation (FDCAX) leads the way. In March 2015, this fund, which carries a Morningstar Analyst Rating of Bronze, held nearly a third of its assets--in a roughly 75-stock portfolio--in biotech and pharmaceuticals. Investors familiar with manager Fergus Shiel's go-anywhere approach should not be surprised. With little regard for benchmarks or style-box 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 it does not preclude him 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 alternative 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 April 2015, the fund's 9.2% annualized gain is in line with that index and about a percentage point better than the S&P 500, though at the cost of greater volatility.

Alec Lucas has a position in the following securities mentioned above: GILD. Find out about Morningstar’s editorial policies.