Why I Am A Biotech Permabull

Includes: DIA, IBB, QQQ, SPY
by: EnhydrisPECorp

A look back over the past year shows that the Dow Jones and S&P 500 are both up over 15%. While that may sound impressive or "bullish" to some, it sounds downright awful to me. I personally wouldn't bother investing in the stock market for a paltry 15% return in a year's time. To be frank, there are far too many risks in the stock market--knowns and unknowns, to make it worthwhile for such miniscule returns. This may sound like a controversial position to some readers, especially given the fact that the DJI and S&P 500 have only averaged about 7.5% in annual returns over the past 10 years. In effect, these indices have actually doubled their performance over the past year, compared to their ten-year averages. But I still think that isn't good enough to outweigh the risks inherent in the stock market in general.

In this article, I show why investors should, quite frankly, start to expect more in terms of return-on-investment (NYSE:ROI) from the market. In doing so, I also show how one sector (Biotechnology) has absolutely trounced the major indices over the past decade, as well as the Oracle from Omaha, Mr. Warren Buffett. And I discuss why the raging bull that is biotech, in my opinion, has only begun to lower its horns for an unprecedented run for years to come.

Biotech versus Everything Else

My claims about biotech may sound outlandish, but the proof is in the pudding. To illustrate my point, I compared the past performance of the Nasdaq Biotechnology Index (^NBI), the Nasdaq Composite Index (^IXIC), the Dow Jones Index (^DJI), the S&P 500 (^GSPC), Berkshire Hathaway A shares (NYSE:BRK.A), and our own private biotech fund (ENY) over a series of intervals (1, 3,5 & 10 years). A quick glance at the graphs below show that the two biotech funds (^NBI & ENY) have put all of these traditional, high quality investment vehicles to shame in terms of performance. The 10-year average ROI per annum for the two biotech funds were 61.4% and 21% for ENY and ^NBI, respectively. Compare that to the 10-yr averages of BRK-A (13.1%), DJI (7.47%), Nasdaq Composite (13.1%), and S&P (7.67%). Taken in this light, the constant chatter about the 2012-2013 bull-run that has resulted in 15-17% gains may sound great, but it pales in comparison to either our fund's 79% year over year performance, or the broader Nasdaq Biotech Index's 38% gains. In fact, our biotech fund has outperformed the S&P 500's performance for entirety of the last decade. That speaks volumes about how poorly these indices have compared to the biotech sector.

One of the most glaring differences among these assets is that the biotech funds were not nearly as volatile during the Global Economic crisis in 2007-2008 as the major indices or Berkshire Hathaway, evinced by the 5-year bar graph below. The biotech sector did drop with the broader market but not nearly as much. And it also participated in the broad market rally that generally occurred ever since. So essentially, biotech has for most part simply kept chugging along during tough economic periods-- due in large part to the fact that these companies are developing new technologies that are radically altering medicine, healthcare, and even daily human life. Very few asset classes can offer such a margin of safety, which is one of Mr. Buffet's favorite criteria when choosing value stocks.

Past Performance is Not a Guarantee of Future Performance

As the classic refrain goes for literally every fund out there, "past performance is not a guarantee of future performance", etc, etc, etc. We have all heard that as active investors, and know it's a blanket statement to cover our broker's behind in the case of poor performance. But I actually believe this is true with the biotech sector, perhaps not in the way you were thinking however.

Biotechnology isn't even close to a traditional industry. In fact, it's perhaps the most important industry mankind has ever created, and is markedly changing human society. The world is facing myriad problems such as overpopulation, increasing demand on scarce energy sources, increasing rates of nearly every disease imaginable, pollution on unprecedented scales, and of course, terrorism. Biotechnology is the industry global leaders are turning towards to mitigate or help solve these problems. As such, the industry has been expanding exponentially since the 1970's, generating fistfuls of cash for early investors along with it. Most importantly for investors going forward, the industry has only entered into its infancy, and where it will go isn't even imaginable as of yet, in my opinion. I have no doubt, for example, that one day the bio-engineering of artificial light-harvesting complexes found in the chloroplasts of photosynthetic organisms will be, at least part, of the solution for the world's increasing energy demands. Such an innovative solution wasn't even on the radar a decade ago, showing how much promise the industry holds.

Even with the industry's far reaching effects on human society, I am not a biotech permabull for these already excellent reasons. I am a permabull because of something called the "technological singularity", coined by Ray Kurzweil. The technological singularity is the logical conclusion of something called "Moore's Law". In a nutshell, technological innovation tends to increase exponentially, leading to a point where humans must either merge with machines or be left behind. This nexus is what Kurzweil calls the technological singularity. While this concept does have its detractors, there is no doubt that technology is becoming intimately integrated into everyday life on a global scale, and technological change is happening faster and faster every year. Just a few years ago, for instance, the term "nanoparticle" seemed, well, futuristic for lack of a better term. Yet, nanoparticles are already being engineered to fight an array of human viruses that have plagued mankind for centuries. That's cool stuff, and is only the beginning.

While more conservative investors may lament that the strong performance of the biotech sector is yet the formation of another bubble soon to burst, I believe it is the future of humanity, and as such, a sector that will make investors unprecedented gains. To show our confidence in biotechnology, we have heavily invested in this sector through our fund, and believe it will continue to outperform the broader indices for decades to come.

That said, I do strongly recommend that investors take a broad approach to the sector in general, and not invest too heavily in any one company--no matter what the promise of the technology may be. Biotech is infamous for its volatility, and a basket approach is therefore well-advised. Our fund, for example, includes 70 companies developing a diverse range of technologies. Even so, approximately 30% of the companies in the fund have turned out to be perpetual losers. Luckily enough, the gains on the winners have more than offset the losses, showing the importance of taking a broad approach.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Our fund is not publicly traded, but is owned by the author as part of his compensation.

Additional disclosure: I am a director of Enhydris Private Equity, Inc., and as such, own shares in the private Enhydris Bio Fund mentioned in the article. This article was researched by Yagmur Kurt, an employee of EPE.