Biotechnology not only saves lives. It can make for a lucrative investment, says Kaul, the portfolio manager of Fidelity Advisor Biotechnology Fund.
Indeed, Kaul likens the biotech industry to Silicon Valley in 1984 when a slew of startups and emerging technology companies kicked off 25 years of immense returns for investors (albeit with one very nasty crash).
The biotech industry, he says, is taking off in much the same way. "My long-term view is that the next five, 10, 15, 20 years for the [biotech] industry will be one of the most promising places to be in the world," he says.
Kaul's optimism stems from advances in diagnostics and genomics, which, he says, are allowing biotech companies to create more targeted medicines with better outcomes. "The quality of drugs in the pipeline should improve," and that, he says, makes him hopeful that the future for the industry will be robust.
The past few years certainly have been significant ones for the fund, which Kaul has managed since October 2005. It was the third best-performing fund over the 12-month period that ended on June 30, yielding 29.3%, according to Morningstar. It enjoyed three- and five-year annualized returns of 21.5% and 11.1%, respectively.
As fund companies are inclined to say, however, investment returns are far from guaranteed. And that's especially true in biotech, which is a risky business with two extremes: companies are either fabulously successful or they fail-fabulously. Companies that manage to find a "breakthrough drug" will enjoy advantages that make them virtually unbeatable in the market, Kaul says.
They'll have "one of the best business models in the world," with high barriers to entry, high margins and intellectual property protection for over a decade.
More often than not, however, new wonder drugs do not live up to expectations. Drugs that show great promise in the lab often don't survive clinical trials, with 80% to 90% of all new compounds failing, according to Kaul.
New medications often take years to get to market, and anything can go wrong as they wind their way through the rigorous regulatory approval process. "The process of discovery is a costly process ... and the cost of failure is very high," Kaul says.
Therefore, when investing, "one has to be conscious of minimizing the risk of blow-ups and disappointment in the labs," he says.
How does Kaul pick biotech's potential future winners? He engages in good old-fashioned "fundamental work," looking at company financials, such as cash flow and earnings growth. More important, he carefully evaluates the potential of each product, assigning each a probability of success.
To do that, he talks to opinion leaders, studies the competitive landscape and assesses pricing challenges, medical need and the global size of the opportunity.
Always, he says, he weighs "the downside risk if one is wrong" with "the returns on the upside if they [the drugs] work out as they should."
In this "fundamental-driven process," Kaul relies heavily on data from clinical trials. It trumps all the other information he collects in his analysis of biotech companies. "Being able to understand the data and being able to understand the value of the data," Kaul says, are critically important in assessing a company's potential.
Kaul favors companies that he thinks have a high probability of success. Very often, those happen to be companies overlooked by Wall Street, those that the Street "perceives to be damaged stories because they don't understand the value of the pipeline," he says.
For example, Kaul bet on Genentech soon after the company received approval in the late 1990s for Herceptin, a drug used to treat a certain type of breast cancer.
While Wall Street had written off the drug, Kaul's fundamental work showed that it could have significant effects on patients and had the potential of being a "mega blockbuster medication." He was right. The drug today has global sales of more than $5 billion and was one factor in making Genentech one of the best investments of the last decade, according to Kaul.
Indeed, in March 2009 Roche paid an eye-popping $46.8 billion for the remaining shares of Genentech that it didn't already own. And that was when the stock market hit a low point. "It was one of the biggest wins for our investors in the last couple of years," Kaul says.
As big as the wins can be, Kaul is cautious in managing downside risks. A small company's stock can fall 80% in one day if one of its drugs fails. To minimize that risk, a majority of the fund's $138 million in assets are invested in large-cap biotech companies, which generally have less risk than smaller ones, Kaul says.