This year's equity performance is heading in the same direction as last year's: heavy on volatility and light on gains. Indeed, the VIX, the market's "fear index", was up 13% in June versus the rest of the year. This fear is fundamentally driven by the instability of the European debt markets. This global issue has taken almost the whole market down with it. We therefore suggest looking at sectors with their own ebb-and-flow which is not connected as strongly to global economics. The classic alternative is the healthcare industry. All of this alarm is still not going to stop the healthcare industry from producing new, innovative treatments and medications. This is why the biotech industry deserves a fair look.
The iShares NASDAQ Biotechnology Index (IBB, 132.27) is the industry leader and has followed the historical script perfectly during the recent market turbulence. As Chart 1 below portrays, this fund returned 2.7% since the April 2nd peak in the market, while the S&P 500 has declined 5.9%. This safe-haven quality should continue into the summer.
Because the biotech industry marches to its own beat, it can be an excellent way for a long-only investor to generate gains while the general market struggles. Each company rises and falls based on the idiosyncrasies of its progress of its drug approval process and business life and needs to be evaluated through that lens.
Chart 1: Performance of the S&P 500 and IBB since the April 2nd, 2012 Peak
Prolor Biotech (PBTH) is a prime example of this trend. This relatively small company (market cap of $240mm) is working on some exciting treatments that will allow patients to take growth hormone treatments on a weekly basis rather than a daily basis thus increasing convenience and the likelihood of continual treatment. With some of the largest pharmaceutical companies in the world already entrenched in the field, it will certainly be challenging to break into this $3 billion industry. For example, the market leader is Pfizer (PFE) with their Genotropin brand, followed by Eli Lilly's (LLY) Humatrope brand, and finally Novo Nordisk's (NVO) Norditropin. These three brands take up roughly 2/3s of the market share and are backed by a combined $315 billion in market capital. But this is an ever-present risk in biotech start-ups and embedded in the price.
Prolor recently announced that they have successfully completed their phase II study of this treatment on adults. The four month study concluded that their weekly dosage provides comparable results to the tedious daily treatments. This is the fourth clinical study in adults. The company expects Phase III (adults) to be initiated later in 2012. With most of the demand for this product in the pediatric segment, the separate youth study bears particular weight. Phase II (pediatrics) studies were initiated in Q1 2012 and have been moving along well. The current products on the market all require daily treatment, so this first-to-market provides a real competitive advantage.
Balance sheet risk should always be on the top of a small biotech investor's checklist. Prolor has recently closed on a public share offering to net $35 million. Adding this to their $9.1 million of cash on their March balance sheet gives them enough liquidity through 2014. While the news brought the share price down temporarily; going forward, fears of future dilutive acts have been cleared for at least the medium-term.
While looking ahead with low visibility into the near-term future, investors should be looking for uncorrelated investments to dampen volatility. The biotech sector offers this type of diversification with the added benefit of outsized potential returns. Further analysis into the sector to pick out winners is the steadiest path to success. Prolor, with Chairman Dr. Phillip Frost, a proven healthcare entrepreneur, at the helm provides a great opportunity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.