Diversification is key to success

For institutional investors, diversification is crucial for achieving the strategic objective of above-average performance over the long run while maintaining a reasonable risk/reward profile. Sectors that are inexpensively valued and will rank among the winners of tomorrow can be found in every viable investment strategy. Biotechnology is one such sector.

Institutional investors determine their portfolio structure based on their risk, return and liquidity preferences or specifications and then allocate their portfolio assets accordingly. In an ideal portfolio optimization process, they will strive to achieve the maximum return within the given framework of risk and deviation parameters. Studies have shown that diversification, the pivotal element of risk management, is a function of expected returns rather than of volatility and correlations.

Allocating investment capital to different asset classes, countries and sectors clearly lowers the downside risk. That is particularly true when investing in stocks, the asset class that has produced the highest returns over time, albeit with the most volatility too. As a crucial element of diversification, exposure to a mix of different sectors plays an important role for successful stock selection. Risk-conscious investors will show a bias towards future-oriented investment themes, i.e., those sectors and technologies that stand to grow faster than the global economy in years to come.

The biotech sector is inexpensively valued

The biotech sector is considered one such mega trend that investors can rely on for sustainable returns for decades to come and it also offers considerable diversification benefits . Lately more than half of all new drug approvals have originated from the labs of biotech companies; last year alone they numbered 46. According to the latest earnings estimates of industry experts, the sector's average annual top-line growth in the coming five years will be in the high single-digits.

Institutional investors such as pension funds, insurance companies, trusts and asset managers include the biotech sector as part of their diversification strategy, not least because of its low correlation to the broader stock market. The Nasdaq Biotechnology Index, the bellwether index for the biotech sector, has displayed a clearly better performance profile over the past ten years than conventional indices such as the DAX or MDAX. 

An attractive valuation is another argument for buying the biotech sector. Major biotech companies that are generating profits are trading on an average P/E of 11 for 2019, which is right in the middle of the historical range. At the same time, many are flush with cash, which makes takeovers a distinct possibility. The primary targets are small and mid-sized companies with novel technology and/or treatments that are on the verge of a market breakthrough.

Biotech in an institutional portfolio

Institutional investors seek stable and sustainable returns (and are therefore attracted to the biotech sector) but they will inevitably be confronted with the question of how to ideally invest in the sector, given that the complexity surrounding biotechnology makes it difficult for in-house research to cover. Then there's often a home bias: German pension funds tend to favor companies from their home market when picking stocks. The small selection of domestic players in the pharma and biotech sectors that have reached critical mass is clearly a handicap.

A good solution here is BB Biotech AG, a listed Swiss investment company whose risk diversification policy is based on a concept that is as innovative and effective as it is unique. For example, its portfolio managers are gradually reducing portfolio exposure to blue chips because they have concluded that small and mid caps offer a clearly better risk/return profile going forward. With regard to portfolio structure, its investment team is not confined by a benchmark or bound by any weighting restrictions or limitations. Core investments can therefore exceed the 10% cap that applies to most investment funds. A steady stream of income is a fundamental criterion for many institutional investors and BB Biotech addresses that need by offering an annual dividend yield of 5%. On top of that, the company conducts share buybacks of up to 5% of its outstanding shares a year.