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Testing conditions for medical fund

Having topped up the Tora tan in the middle of the Atlantic (well, pretty much the middle) I could not resist the opportunity to parade myself in front of IFAs in South-west England. The topic is my now familiar case to re-embrace the cult of the equity but go easy on the greed element. As you read this, I should be telling the good folk of Devon and Cornwall that things will get better but not necessarily easier. Prepare for a prolonged period of lower returns.

We all became too used to big stockmarket profits and the collapse of the technology market brought a much needed dose of reality. My colleague Logie Cassells, manager of the Hallmark Portfolio Funds, has come up with an interesting analogy. He has likened the behaviour of the technology market to that of the US automobile industry in the period between the two world wars. Incredibly, there were more than 100 car makers in 1918 but, helped by the Depression, fewer than 40 remained by the end of the 1930s. Part of the reason was the growing penetration of the US consumer market by car manufacturers. It became more difficult to remain in what had become a competitive business unless you had something that marked you out from your peer group. I agree there are similarities with today&#39s crowded market for personal computers.

What this proves is that there is nothing new under the sun. The errors we make are usually in believing this time things are different. I hold my hand up. That was certainly my view. In some ways, I still believe it to be true. This time is different but more in the speed at which adjustments take place than in the belief that any industry can buck cycles indefinitely. Moreover, it is different because governments are encouraging personal investment. That, at the very least, has to be good for markets.

We have seen better conditions recently, with markets on both sides of the Atlantic recovering from their early spring lows. Falling interest rates have undoubtedly helped. Even the European Central Bank bowed to pressure and joined the party. Yet almost immediately afterwards came confirmation that inflation is still a worry in the eurozone while forecasts for growth appear remarkably upbeat. Not so in the US, where the Federal Reserve Bank lopped yet another 50 basis points off interest rates. What does that tell you – that they put them up too far in the first place, perhaps? Still, US inflation does not look to be a problem.

Our own monetary policy committee will probably consider any change to interest rates ahead of the election politically incorrect. There is some justification for taking no action, with UK inflation looking rather more robust than many were expecting. In part, this is due to higher energy costs although utility charges are also up. Strip those out and an altogether more subdued picture emerges. I still do not think inflation will come back to haunt us too early.

It is surprising there are not more worries about inflation, given that labour market statistics published last week showed wage costs rising at their fastest rate for some time. Even there, you have to look through the bare statistics to realise that headline figures do not provide the full story. Employment is continuing to contract in the manufacturing industry, with strong sterling exacting a price from these sectors of the economy.

But greater stability in the stockmarket suggests investors are looking to better times ahead in the second half of the year. Whether these better times will extend across the whole range of businesses is another matter entirely. New economy stocks may have bounced but the pressure is still there. Indeed, at the end of last week, the FTSE 100 index exc TMT was close to an all-time high. What a difference a year makes.

Schroder&#39s Medical Discovery fund has become one of the most successful healthcare funds on the UK market since its launch a year ago. Strong performance in the sector, which saw the MSCI world healthcare index rise by more than 20 per cent in 2000, helped the fund grow to just under £80m.

But market conditions became somewhat more testing after the start of 2001, with the fund down by some 6 per cent. The index suffered an even bigger fall.

Fund manager Kristine Bryan says: “The healthcare sector took a tumble at the very beginning of this year when Alan Greenspan made his first interest rate cut. The whole sector lost £100bn in market capitalisation in less than 24 hours.

“The sector had peaked at the end of last year so it was a very easy source of cash for investors to quickly switch into more economically sensitive areas of the marketplace.”

Since April, however, there has been a change in fortunes. In the past month alone, the fund has grown by more than 6 per cent and Bryan seems optimistic that market conditions are on the turn.

She says: “I would be breaking the law by telling you how I think my fund is going to perform by the end of the year but I will say that the average earnings growth for my fund has prospects of 15 per cent and I would hope, on any given year, on average, the fund would be able to grow at least in line with average earnings.”

With only a small proportion of the portfolio held in biotech stocks, the fund carries a slightly lower risk profile than most of its peers. But although its performance over the short term has been generally stronger than its rivals, Bryan is not keen to make comparisons.

She says: “It is unfair to compare me with Framlington because we have different mandates. My mandate is to invest in healthcare worldwide, with the focus on outperforming the MSCI world equity markets over time. My fund is meant to invest in everything from the biggest pharmaceutical company in the world down to the smallest biotech company and to be a broad and diversified healthcare investment.

“The Framlington fund has a different index mandate. It has 50 per cent of the fund or more in biotechnology. So, although they are both healthcare funds, they are very different and address different needs for different investors. By definition, a fund that has a higher percentage of investment in biotechnology takes on both potential risk and reward and would be for an investor who is willing to take on a higher degree of risk for a potential higher reward – a different type of investor.”

Bryan keeps the biggest part of her portfolio in large-cap pharmaceuticals but says her aim is to keep the fund as broadly invested as possible. Her biggest holding is now US drug giant Alza after it bought out Johnson & Johnson earlier this year.

Biotech makes up only a small proportion of the fund although Bryan says she has taken a slightly bigger position over the past few weeks.

She says: “We have been adding to all categories but I would say there has been a greater focus on taking some of the opportunities we have seen in the first quarter to add to our biotech positions because the sector has been so weak.We have been adding to the medical devices and services areas due to some opportunities in new companies which have done well since we have invested in them.

“We have probably been adding a little more in the US due to relative valuations compared with the UK and Japan but we will continue to take a bottom-up approach. We are being sensible about this being a global fund and will always have exposure in the major markets.”

Bryan insists she keeps a strong sell discipline within the fund although she admits there has not been much turnover during its relatively short lifetime. She says: “By the nature of it being a new fund, there has not been as much selling as you would see in a mature fund because of the constant inflow of funds. Having said that, if something changes dramatically relative to an investment thesis on a company, I will most certainly eliminate the position.

“The biotech portion of my fund turns over much more rapidly than the large-cap pharmaceuticals and some of the more established companies and we certainly do have price discipline on biotech because they are smaller positions in the fund.”

Having been one of the top-selling funds over the last Isa season, the fund has already grown into the secondbiggest healthcare unit trust and has made it on to many IFAs&#39 buy lists. Nevertheless, Bryan says there are no immediate plans to extend the range to include a higher-risk offering such as a pure biotech fund, even though the indications are that it could be well received.


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