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The biotech group as represented by the NYSE ARCA Biotech Index ($BTK) has been weak this year, now down over 30% from the highs it hit earlier in the year in May. In this article, we discuss the investing activities of the world’s largest fund managers, managing between $100 billion and over a trillion dollars, in small-cap biotech stocks, based on the latest available Q3 institutional 13-F filings. Taken together these mega funds are bearish on the group, cutting a net $103 million in Q3 from their $6.64 billion prior quarter position, and they are also equal-weight in the group (for more general information on these guru funds, please look at the end of the article). We have broken the biotech group by capitalization due to the sheer size of the group, and the fact that larger biotech companies with commercial product portfolios attract a more risk-averse and conservative investors who look for revenues and sustained profitability in constructing their value thesis. Small-cap and micro-cap biotech companies in contrast generally have no commercial products, but rather a pipeline of product candidates being tested in early- to sometimes mid- or late-stage clinical trials for a variety of disease conditions, and hence they generally attract a more speculative investor due to the uncertainty associated with the cash flow from their product portfolios.

The following are the small-cap biotech companies that mega fund managers are bullish about (see Table):

Optimer Pharmaceuticals (OPTR): OPTR focuses on discovery, development and commercialization of hospital specialty products such as products that treat gastrointestinal infections and related diseases. Its commercialized product portfolio includes only DIFICID that was launched in July for the treatment of Clostridium difficile-associated diarrhea (CDAD) in patients 18 years of age and older, and its lead product candidate includes Pruvel for the treatment of infectious diarrhea that is currently in phase 3 trials. Mega funds added a net $3 million in Q3 to their $164 million position in the company. The largest mega fund buyer of OPTR in Q3 was Fidelity Investments ($26 million), which was also the largest holder at the end of Q3 ($44 million). OPTR currently generates losses and is projected to continue to do so for a while, however, its revenues are on a strong upward trajectory, driven mostly by the recent launch of DIFICID on July 19th. The shares traded lower recently after the company missed its projected loss estimates for Q3.

Vical Inc. (VICL): VICL develops DNA-based vaccines and therapeutics to prevent and treat cancer and cardiovascular and infectious diseases. Mega funds added a net $8 million in Q3 to their $66 million prior quarter position, and together they now hold an outsized 40.6% of the outstanding shares. The largest mega fund buyer in Q3 was Fidelity Investments ($16 million), which was also the largest holder with $23 million. VICL shares have been among the best performers in the group this year, up almost 120% YTD, buoyed on positive developments in its pipeline, particularly on its lead product Allovectin being tested in phase 3 trials for metastatic melanoma.

Endocyte Inc. (ECYT): ECYT develops targeted therapies using small molecule drug conjugates for the treatment of cancer and inflammatory diseases. Mega funds added $10 million in Q3 to their prior $20 million position, and together they now hold an outsized 48.3% of the outstanding shares. The largest buyer in Q3 was Fidelity Investments ($4 million), who is also the largest holder with $19 million. ECYT shares are among this week’s strongest movers to the downside, down 72% this week so far, after the company announced on Tuesday the results of supplemental analyses of its phase 2b PRECEDENT trial that failed to show a survival advantage.

The following are select small-cap biotech companies that these mega fund managers are most bearish about (see Table):

Arena Pharmaceuticals (ARNA): ARNA is a biotech developer of oral drugs for cardiovascular, central nervous system, inflammatory, and metabolic diseases. Mega funds cut a net $7 million in Q3 from their $77 million prior quarter position in the company. Wellington Capital Management was the largest seller by far, selling $8 million in Q3 from its $31 million prior quarter position. Wellington has been aggressively reducing its position in ARNA, and in fact, just last week we reported that Wellington filed SEC Form SC 13G/A indicating that it now holds 9.1 million or 6.3% of outstanding shares of ARNA, a decrease of 2.1 million shares from the 11.2 million shares that it reported holding in the 13-F filing for Q3. Even after this sell, Wellington is still the largest institutional holder in ARNA, with Vanguard Group being the next largest with 4.7% of the outstanding shares. ARNA shares have rallied strongly recently, up more than a double since the last week of November when the stock started rallying on positive comments from Piper Jaffray regarding its upcoming NDA re-submission to the FDA for lorcaserin.

Spectrum Pharmaceuticals (SPPI): SPPI develops innovative therapies with a focus in the areas of hematology and oncology. Mega funds cut a net $16 million in Q3 from their $234 million prior quarter position in the company. The largest mega fund seller in Q3 was State Street Corp., selling $10 million from its $44 million prior quarter position. SPPI stock has been among the best performers in the biotech group lately, having more than doubled since the beginning of October, mostly on the basis of strong operational data for its Q3 in which revenues ($51 million versus $40 million) and earnings (34c versus 10c) topped estimates. SPPI trades at 18 forward P/E and 4.8 P/B compared to averages of 31.8 and 6.2 respectively for its peers in the drug manufacturers group; however, earnings after staging a turnaround in 2011 are expected to drop from 97c in 2011 to 82c in 2012.

Antares Pharma Inc. (AIS): AIS is a developer of trans-dermal and intra-dermal therapeutic delivery systems, including needle-free and mini-needle injector systems and gel technologies. Mega funds cut a net $1 million in Q3 from their $28 million prior quarter position. The bottom fell out from under AIS shares today after its partner Biosante Pharmaceuticals (BPAX) announced that Libigel for female sexual dysfunction had failed to show a statistically significant difference in two pivotal trials versus those on placebo. AIS had planned to develop the delivery system for the drug, and so it fell along with the steep 80% plus drop in BAPX shares last week.

Avanir Pharmaceuticals (AVNR): AVNR develops therapeutic products for the treatment of chronic diseases, including central nervous system and inflammatory diseases. It currently markets FazaClo for severely ill schizophrenic patients who fail to respond adequately to standard drug treatments for schizophrenia, and it has an ongoing program with Novartis (NVS) for the treatment of inflammatory disease. Mega funds cut a net $5 million in Q3 from their $112 million position in the company. The top seller in Q3 was Deutsche Bank ($2 million). AVNR shares have been among the weakest performers in the group this year, down 55% YTD.

PDL Biopharma Inc. (PDLI): PDLI develops treatments for cancer and immune disorders based on proprietary antibody humanization technology. Mega funds cut a net $22 million in Q3 from their $350 million prior quarter position, and the biggest sellers were Goldman Sachs Group ($6 million), Invesco Ltd. ($5 million) and Credit Suisse ($4 million). PDLI trades at 4-5 forward P/E compared to the average 31.2 for its peers in the genetics biotech group.

Table


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General Methodology and Background Information: The latest available institutional 13-F filings of over 30+ mega hedge fund and mutual fund managers were analyzed to determine their capital allocation among different industry groupings, and to determine their favorite picks and pans in each group. These mega fund managers number less than one percent of all funds and yet they control almost half of the U.S. equity discretionary fund assets. The argument is that mega institutional investors have the resources and the access to information, knowledge and expertise to conduct extensive due diligence in informing their investment decisions. When mega Institutional Investors invest and maybe even converge on a specific investment idea, the idea deserves consideration for further investigation. The savvy investor may then leverage this information either as a starting point to conduct his own due diligence.

Credit: Fundamental data in this article were based on SEC filings, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.

Disclaimer: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Further, these are our ‘opinions’ and we may be wrong. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. If this makes you uncomfortable, then do not listen to our thoughts and opinions. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial adviser before making an investment decision. Investing includes certain risks including loss of principal.

Source: Q3 Small-Cap Biotech Picks By The World's Largest Fund Managers