Is the Time Right to Invest in Biotech? Soros Thinks So

George Soros certainly thinks so.  In a 3rd quarter 13-F filing for Soros Fund Management, the noted hedge fund manager initated two new biotech positions, immediately placing them into his top 10 holdings–Dendreon (NASDAQ: DNDN) and Teva Pharmaceuticals (NASDAQ: TEVA)–and a third smaller position (Mindray Medical), while shifting a portion of his sizable allocation away from Gold and materials. This comes just one quarter after making a substantial investment in Salix Pharmaceuticals (NASDAQ: SLXP).

The biotech sector has been largely out of favor for years now. The monthly chart of the Biotech HOLDRs ETF (NYSE: BBH) provides a perfect visual of the story:

Biotech monthly

This particular ETF is heavily weighted towards industry leaders Amgen (NASDAQ: AMGN), Gilead (NASDAQ: GILD) and Biogen (NASDAQ: BIIB), but has fairly diverse and deep holdings beyond the big three.  Moreover, the fourth largest holding is Genzyme (NASDAQ: GENZ), which if nothing else, has contributed nicely to the upside since the mid-summer takeover rumors from Sanofi-Aventis (NYSE: SNY) lit a spark.

Running through the price history quickly, we can clearly see the fallout in the wake of the crash, a time in which the next hot biotech was equally en vogue to the newest Internet startup.  People were paying substantial premiums for development stage science and that was certainly an unsustainable frenzy.  However since that time, the sector has remained completely stagnant from a market-cap perspective while earnings growth has continued apace.  When this happens, the end result is multiple compression and the lowering of the implicit growth expectation built into the price of the companies themselves.

In Soros’ latest top-10 positions we have one company–Dendreon–which recently received FDA approval for a groundbreaking cancer therapy and the first to be designated a “vaccine” for the way it turns the immune system against cancerous cells in the body, and a second–Teva–that produces and markets various kinds of generic pharmaceutical products.  This positioning aims to capitalize on two of the prominent secular themes that are taking hold in biotech today.  On the one hand we have a wave of new innovative treatments nearing medical use.  On the other hand, many of the staples of the big pharma portfolio drugs are approaching the date in which their patent expires, thus opening the door for generic drug makers to vastly more potential products and markets.

Biotechs have unique risks in contrast to your typical stock, mainly the regulatory hurdles that inevitably occur throughout the sector.  However, biotech also enjoys a unique benefit as a portfolio allocation compared to many sectors, especially with questions over health care in the rear-view mirror.  With biotech, the success or failure of an entity occurs largely independent of the broader economy.  Stated another way, when investing in biotechnology, your risk/reward scenario sets up independent of any potential big picture headwinds.  This is clearly evident with how well the Biotech HOLDRs held up during the 2007-09 turmoil.

Following decades of multiple compression in the sector, George Soros’ just might be onto something in making this a focal point for his portfolio moving forward.

Disclosure: Long DNDN