Tomorrow's Biotech Winners Fuel Fidelity Funds

Rajiv Kaul hunts for the next big thing in biotech. As manager of the nearly identical Fidelity Select Biotechnology (symbol FBIOX) and Fidelity Advisor Biotechnology (FBTAX) funds, he attends conferences, talks up experts and studies data to find biotech companies with promising drugs.

Once he identifies a potential investment, Kaul tries to predict how successful a drug could be. To measure that, he seeks to determine how many people would take it, how many doctors would prescribe it and what the competitive landscape looks like. Kaul tends to avoid companies with drugs in early-stage testing because there's too much uncertainty about a product's success. "I'd rather wait until the drug gets approved or we have data that shows it works," says Kaul, who has managed both of the biotech funds since October 2005.

That said, both funds hold speculative biotech firms as well as established, profitable outfits. At last report, Select Biotech's three biggest holdings were Gilead Sciences, Biogen Idec and Celgene (all profitable and accounting for 23% of Select's assets). A hefty one-fourth of the fund's assets are in so-called microcaps (companies with market values of $300 million or less), including such money-losing obscurities as ArQule and PolyMedix. "I try to strike a balance between investing in firms that generate a steady stream of cash and those that offer a growing pipeline" of new products, says Kaul.

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Once Kaul finds a potential winner, he estimates how much cash flow a company could generate from a drug over ten years. Using these projections, he determines a company's value. If a stock sells for less than his estimate, he buys.

Both funds follow the same strategy and have similar holdings, but they charge different fees. Select Biotech is sold directly to investors and will slap you with a 0.75% charge if you sell shares within 30 days of buying them. Advisor Biotech is only available through financial intermediaries and comes in a variety of share classes with different fee structures.

Over the past year through April 30, Select Biotech returned 19.6%, beating the average health-care fund by nearly 14 percentage points and Standard & Poor's 500-stock index by 15 points. Over the past five years, Select Biotech gained 8.9% annualized, topping the average health fund by an average of 4.0 points per year and the S&P 500 by 7.9 points a year. The Class A shares of Advisor Biotech returned 20.9% over the past year and 8.6% annualized over the past five.

As for biotech's future, the best is yet to come, in Kaul's view. "Science has greatly advanced over the past few years," he says. "We're at an inflection point where there will be a lot of innovation over the next ten years." He also thinks big drug makers will continue to snap up biotech companies to fill empty pipelines with new products.

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