"Over the last 30 days the advances that have taken place in genomics is probably one of the most meaningful things that we will see in our lifetime. We have sequenced the genome. This provides us a roadmap that tells us when we'll be born and when we'll die. And the understanding of all that information is so complex that it has taken the computer industry a decade to do it. What we have is a dictionary to our body, but we don't know how it all goes together, how it all works. Over the next decade we will be putting all that we know together; we'll be studying functional genomics"
- Kurt Von Emster
Test tube babies, cloned sheep, vegetables crossed with fish genes to make them look juicier...these are just some of the images that may spring to mind when one thinks of the word "biotechnology". But before you get carried away with visions of humans morphing into insects (think of the 80's blockbuster film, "The Fly"); it's best to remember that biotech research has more to do with understanding the way in which the human body fights disease than anything else. Enter the Human Genome Project. Completed just recently, it maps the genetic code of the human body. All 3 billion bits of it. Scientists now say that within years, we can tell from birth the kind of diseases that we'll develop in later life, and treat them before they cause complications. The possibilities of such research are enormous.
Kurt Von Emster is a believer. Not just in the ability of biotechnology to improve our lives, but also in the opportunities that it offers ordinary investors to make money. He's the lead fund manager for the Franklin Templeton Life Sciences Fund which was launched recently in Singapore. The feeder fund is managed from overseas. Fundsupermart caught up with the American during his brief stop here.
Q: The Franklin Templeton Life Sciences Fund has seen phenomenal growth in the last two years. How long can it sustain such high returns?
A: The returns we have had over the last year are not normal. The Franklin Templeton Life Sciences Fund is up 70% from last year, and we can probably see another 50% from here. Those returns will not be had each year. But if you average them over a long time period we do believe that the total return of the life sciences sector is in excess of market expectations. But over each year, we are market dependent. Biotechnology does not exist on its own. It's very drawn to what the NASDAQ is doing, and if the NASDAQ goes down, than the biotech will as well. The performance of biotech stocks is also driven by how much demand there is for biotech stocks. Biotech is a very small group of companies with a market valuation of about US$ 400 billion now. It is one tenth the size of the technology sector. The volatility in biotechnology is extremely high. We want volatility, because it gives you returns of 250%. It also gives you negative returns from time to time over short periods of time. This fund is not for every investor. It's for people who have a longer term view and recognize that life sciences is the future of where medicine is going right now. So its not just a fad or short term trend. The volatility is going to add an ebb and flow to this sector. We expect rises of 50% and falls of 50% as well.
Q: How then do you minimize this volatility?
A: We diversify this fund. We're not just investing in drug companies. These are not all the same type of companies in one fund. We have what's called a three legged strategy. We have large established life sciences companies like Amgen, Biogen and Genentech - they represent a third of the fund. We have the life sciences discovery companies, that over the next couple of years are going to be the next Amgens, with the next generation of products. They represent another third of the fund. The remaining third is invested in companies like PE Biosystems, that make the machines that are used by the biotech companies. Included are companies like Molecular Devices that make the machines that screen the different drugs for efficacy in cells. These are profitable companies with a built in customer base - the biotech companies themselves. And they don't have to worry about regulatory bodies like the FDA telling whether or not they can sell their products.
We also have a very dedicated staff of 5 healthcare analysts, 3 specifically dedicated to the biotech industry. In the U.S we are the second largest biotech investing fund company. That gives us special access to companies managment teams. The biggest thing we offer clients is that we (the fund managers) are located in the largest biotech community in the world. That means that my access to information is much quicker. When I want to ask one of our companies a question, I can drive over and sit with the CEO and his team and talk to them within 15 minutes. That's a key advantage. We go to the scientfic meetings which are important for the industry and we look at what's being developed today. After consulting our doctors we go to the companies that make those products and offer to make an investment. Because of our size we can usually make a direct investment in that company or we can go out and buy shares of that company. Its a real hands on bottom up approach to investment.
Q: Are you concerned that some of these companies might be overvalued?
A: In some cases there are biotech companies that are probably over valued. One of the interesting things about biotechnology is there's no way to value biotech companies unless they are earning money. The 14 or 15 that are profitable now, can only be valued by calculating their earnings prospects. For those that aren't profitable now; you have to imagine when they are profitable in a few years, discount that and assign some risk to it. And then there are some companies that won't earn money for the next 5-10 years. For example, genomics companies. Profitability is really not part of their business model right now. So we look out for companies that have good prospects and are relatively inexpensive. From that standpoint there are great opportunities. There are some companies that though expensive, will continue to increase in value. Our goal in this fund is to look for opportunities in this sector that will support a generally rising valuation across a 3-5 year time period.
Q: Why do you invest in genome companies like Celera? They may have helped map the genetic code but they don't appear to be selling any specific products.
A: We own genomics stocks. We have to as life sciences investors, as it will impact our lives at some point. We normally invest in companies that will make money. However, the business plans of the genomics companies do not lend themselves to making money. In this fund we own Insight, Celera and a couple of other smaller names. But financially as an individual stock, I am buying alot of promises and future value. So I have to be very careful about when I own these things and how I own them. I am dramatically underweighted in this area right now because they have had a huge run over the last 6 weeks. Our investment in Celera went from 50 to 100 dollars, and we did sell in light of all the newsmedia hype. We had positioned ourselves earlier before the announcement of the completion of the Human Genome Project. After that we pared down our investment in genomic stocks. Although it will always be a portion of the fund; at the moment genomics is not a strategic portion of the investments in the fund. Right now we are focused on companies in the areas of infectious diseases and cancer. The reason being that these companies will bring products to the market alot faster than expected. This will coincide with important announcements on infectious disease research in September.
Q: We know that most of the big biotech firms are located in the U.S. But how abut the Asia Pacific? Would you consider investing in biotech companies in this region?
A: While I'm here I'll be speaking to the people at the Institute of Molecular and Cellular Biology. Also many of the companies that we are signing up with are in turn signing partnerships with the Economic Development Board to do life sciences here. That will spawn Asian companies in the next 5-10 years who will be experts in certain areas of life sciences. We'd like to be in there early, so we can identify opportunities and invest in them. In Japan there is an emerging area of biotechnology coming up via the pharmaceutical sector. That's of interest to us. Our analysts travel all the time and right now one of the biggest emerging markets for biotechnology is Germany. That's because the government set up 5 years ago the same programme that Singapore has set up recently. These are the kind of opportunities that we have to recognize early.
In Asia at the moment we have zero investments in the fund. And that's not because we don't want to invest but because the life sciences industry in Asia is very small. We could invest in some of the Japanese pharmaceuticals that look like biotech companies but that's relatively it. I applaud Singapore's efforts for what they are doing but it obviously won't yield direct investment opportunities in the next 5 years. Asia represents less than 1% of the world's market for smaller life sciences companies, so they won't be represented in this fund right now. But its not a coincidence that we are launching here in Singapore, as one of our first international markets. We are launching in UK, Singapore and Germany on purpose, because we feel that these are the more experienced and knowledgeable marketplaces. And with the investments being made by the government here in the biotech sector, we will be looking out for investment opportunities down the road.
Kurt von Emster is Vice President and portfolio manager for Franklin Advisers, Inc. He manages Franklin Biotechnology Discovery Fund, Franklin Global Health Care Fund, and Franklin Valuemark Global Health Care Securities Fund. Mr. von Emster specializes in the research analysis of health care equity securities. He also works on Franklin Small Cap Growth Fund, Franklin DynaTech Fund and Franklin California Growth Fund. Mr. von Emster joined Franklin in 1989 as a management trainee. Mr. von Emster received his bachelor's degree in business and economics from the University of California at Santa Barbara. He is a Chartered Financial Analyst (CFA) and a member of the Security Analysts of San Francisco.