Should you put money in biotech?

Biotechnology is a buzzword that has been exciting investors for decades, but while some have multiplied their money many times over, others have suffered painful losses. Between 2015 and 2016 the entire sector fell heavily, thanks to concerns about the prospect of a more draconian US approach to drug price regulation.

From July 2015 to the following February, the US-focused Nasdaq Biotechnology index fell by more than 30pc and the MSCI World Biotechnology index by 20pc. Some individual funds fell even more heavily.

The sector has now recovered and excitement is building once more – but should investors pay attention?

Biotech companies are mainly involved in developing new drug treatments, tests and other medical technologies. The sector is notoriously volatile, in large part because investors are often banking on a firm’s latest drug or treatment receiving regulatory approval, where the chances of success are low.

Individual companies can, and do, go bust or suffer huge share price falls, and the sector is heavily sensitive to the actions of regulators.

For instance, biotech company Prothena – the top holding in famed investor Neil Woodford’s Patient Capital trust – has recently come under attack from an American hedge fund, which is betting against the stock as it expects its flagship drug to fail. The shares fell by 9pc when the assault became public.

Gary Potter, a multi-asset manager at F&C, the investment firm, said he had never invested in biotech. “On a risk scale of one to 10, biotech has to come in at a nine or a 10. You could lose 50pc in a bad market – people have done, and will do again. It’s an easy story to sell, and I’ve heard it for 20 years,” he said. “The chance of success is there, but there’s a big health warning.”

However, a company that gains approval for a new treatment can deliver spectacular returns, and many long-term investors have been handsomely rewarded. Over the past 10 years the total return of the MSCI index has been 560pc, while the NASDAQ index has returned 530pc.

Peter Hughes, a healthcare analyst at Axa Investment Managers, said that at the point companies became available for public investment they were typically at the “development” stage, which comes after the initial discovery behind a new drug.

“Only one in every 10 drugs that reaches the first stage of clinical trials gets approved, so the attrition rate is still high,” he said.

A “generalist” fund that has decent exposure to biotech firms is likely to be the best option for most investors.

Philippa Gee, of Philippa Gee Wealth Management, said: “This is such a niche sector, you need to be prepared to time both when you go in and when its money in biotech, with the rest in growing technology businesses and energy services. It costs 1.14pc a year.

A general healthcare fund, which can invest in hospitals, pharmaceutical companies, biotech firms and more, offers a more targeted option. Top picks include Axa Framlington Health and the Worldwide Healthcare investment trust, which cost 0.82pc and 0.9pc respectively.

Ryan Hughes, head of fund selection at the investment shop AJ Bell, said Axa’s fund offered broad exposure to large pharmaceutical companies alongside smaller biotech firms, while Worldwide Healthcare is a higher-risk option, as the trust borrows money in an attempt to enhance returns.

For those who would rather invest via a tracker fund, L&G’s Global Healthcare & Pharmaceutical tracker follows a FTSE index of health firms for an annual charge of 0.31pc.

There are a number of specific biotech funds for those who do want direct exposure. The Biotech Growth Trust is in our Telegraph 25 list of favourite funds and charges 1.1pc. Axa, Polar Capital and Pictet all offer openended biotech funds.

Alternatively, you could invest in the Nasdaq Biotechnology index via the US-listed iShares Nasdaq Biotechnology ETF for a charge of 0.47pc a year.

Investors are increasingly wary of stock markets, with many dumping their UK shares and sheltering in more cautious investments, such as bonds.

According to figures from the Investment Association, a trade body, September was a record month for investments, with investors putting £5.6bn into funds. It continues a record-breaking year, with investors putting £33.7bn into funds in the first nine months of 2017 – the highest amount ever.

However, the figures also reveal that investors are selling out of funds invested in the shares of British companies, with £103m pulled in September alone – a trend that has been seen all year.

Instead, they are sheltering in bond funds, with £4.9bn put into them in September – accounting for the lion’s share of the inflows.

Of that, £2.3bn was put into “strategic” bond funds, which hand the responsibility of picking between different bonds to the fund managers.

Laith Khalaf, of Hargreaves Lansdown, the fund shop, said: “Sales of bond funds have picked up significantly over the summer months, which is bizarre given the heightened expectations of rising interest rates over this period.

“Much of this money has flowed into strategic bond funds, which in theory have the flexibility to shelter investors from the worst ravages of rising rates on fixed income prices, if the manager makes the right calls.”

Jason Hollands, of broker Tilney Bestinvest, said investors are wary about the UK stock market.

“There is growing scepticism about how much longer this bull market can continue,” he said.

He put this down to concerns about Brexit, a fragile Government and the rising popularity of the Labour Party. The rest of investors’ money in September went to funds investing in Europe, America and global stock markets.

Biotechnology offers the prospect of both huge gains and painful losses. How can you get exposure while keeping risks to a minimum? James Connington offers some options ‘The chance of success is there, but there’s a big health warning’