TCS Daily

The Battle of Biotech

By James K. Glassman - October 15, 2001 12:00 AM

Even before the Anthrax attacks, biotechnology carried the potential to vastly improve medical care and relieve suffering. Now biotechnology may turn out to be the savior of Western Civilization. Whether the next generation of terror attacks will feature more Anthrax by mail, smallpox, or any of a host of deadly microbes, we could be entering a prolonged battle of biology.

No link has been proven yet between bin Laden and the latest bio-assaults. But we should have no illusions about the appeal of bio-weapons to the evil practitioners of terror, or about the potential harm. And whether it's vaccinating the healthy, treating the sick or developing new weapons to defend the nation on a microscopic scale, America's bio-medical research industry will play an even more important role in our society.

Trying to invest in the companies that will save us from this deadly scourge makes sense, but biotechnology firms are notoriously difficult to evaluate and often carry a huge amount of risk. As we've discussed in previous columns, such firms often lose money for years as they await the results of clinical trials and FDA reviews of their proposed therapies.

Predicting whether a scientist with a promising concept will someday build a profitable business is a major challenge, even for those who fully understand the chemistry. So watching biotech firms is sort of like watching opposing batters face Randy Johnson. There are a few home runs, and lots of strikeouts.

Therefore, for the biotech/health care dollars in your portfolio, it makes sense to invest in a mutual fund dedicated to this sector. The fund should have investments in a number of smaller biotech firms, but also in larger, profitable pharmaceutical and health care firms. That's because many of the larger firms have already bought development and marketing licenses for the technology created by the upstarts, and the established pharmaceuticals continue to pour billions into their own in-house research to develop their own technology. In addition, a bio-war would mean even heavier spending on all kinds of health care products and services used to treat the sick, not just the latest gene therapies.

Which fund to choose? Well, a strong case can be made for the Vanguard Health Care Fund, recently lauded in two separate fund guides from The Wall Street Journal/Morningstar and Money magazine. You may know Vanguard as the large provider of index funds, but this particular one is NOT an index fund. It has been actively managed by Vanguard's Edward P. Owens since 1984. Owens selects health care stocks he believes will be excellent performers over the long haul, and so he tends to hold stocks for a longer period than many fund managers. As Owens recently told The Wall Street Journal, "I'm always trying to think longer term than the typical investor." Owens believes - as I do - that in good times and bad, large pharmaceutical firms are a great place to invest your money. (In my forthcoming book, "The Secret Code of the Superior Investor," out in December, I have a chapter lauding pharmaceutical stocks, "Do Drugs.") So "big pharmas" usually comprise the bulk of the fund's portfolio. And Owens has had tremendous success in choosing which particular health care firms deserve his clients' money. For the 10-year period ending in September 2001, Vanguard Health Care was the top-ranked mutual fund in The Wall Street Journal survey, delivering a stellar 20.9% average annual return.

As the Journal's Kara Scannell noted, Owens "is no stranger to the winners' circle in our contest; his fund also was the best performer for 10-year periods ended in 1998 and again earlier this year." So the fund has performed brilliantly over the long haul, and the short haul hasn't been too shabby either. Vanguard Health Care boasts a total return of almost 86% during the last three years. Not bad when you remember that the broader market has been taking a beating for the last 19 months.

Expenses for the fund amount to just 34 basis points (about one-third of a percentage point) per year, a bargain for a successful, actively managed fund, which, more typically would be charging 150 basis points. The only knock on this fund is a big one - because the fund has gotten so popular, Vanguard can be very choosy. The minimum initial investment is $25,000. But don't despair if you can't afford it. Another way to benefit from Owens's stock picking is to buy what he buys. In recent months, he's been loading up on Bayer, the German conglomerate that makes Cipro, among other things.

Bayer's American Depositary Receipts (ADRs), the equivalent to regular shares of stock, are available on the Over-The-Counter market under the symbol BAYZY. Remember that Bayer has had management problems lately, and it's a good idea always to spread your biotech (or even conventional pharma) holdings wide.

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