Long-running healthcare investing

Antony Milford has one of the longest track records in the UK funds industry, having worked with Framlington since it began in 1969. In fact, Milford is the last surviving member of the original three who started with Framlington at that time. The other two were Bill Stuttaford, chairman and founder, and Tim Miller.

Having fulfilled a number of roles at the group, including his time as deputy chairman and investment director, Milford has especially been known for his work in US equities.

More recently, Milford has come to be known for Framlington Health, the longest operating healthcare fund in the country, which he has managed since 1989.

Over the past year, the fund has received enormous attention as it posted 100%+ returns over the three years to early March.

Despite the market volatility that has rocked the global markets recently, Milford remains convinced of the long-term story in healthcare and especially the opportunities offered by biotechs.

Keeping the fund with a 35% weighting in biotech, Milford is less positive on the large drug companies, which are typically considered defensive plays. Preferring small to mid-cap firms, he has avoided large stocks, such as Glaxo, believing their growth opportunities are limited.

Framlington Health has been around for more than 10 years, why do you think is it only now that interest has taken off in the fund?

It did take a while for interest to gather in healthcare, but it should have happened 10 years ago. Sector funds were not on the map a decade ago. Although there were a handful of technology funds, they did not last long and there was no other health fund. That said, US mutual funds have always invested in healthcare, but in the UK, even today, there are surprisingly few health funds given the size of the industry and the technological innovations that are changing the face of it.

Now that sectors have become more mainstream, there is interest developing. A lot of money has been raised in the past 15 months, however, we are also a fund with a long-term track record, which has helped.

Is one of the attractions of the fund the fact that healthcare is seen as both a defensive play and a growth one?

It is certainly true that it is a non-cyclical growth industry but only parts of healthcare are defensive. Drug companies, hospitals and distributors, which are seen as defensives, have done well in the recent volatile markets, having benefited from investors getting concerned about the economy.

The biotechs have not acted so well but there has been no rationale to this, they have been caught up in what is happening on the Nasdaq.

In 1994, there might have been serious questions of whether the biotechs would have the money to keep going, but today there is not. The biotech industry is in fact well funded and yet the average biotech company is now down some 50%.

During the recent volatility, Framlington Health has not fallen as far as some of the technology funds but that is due to the defensive part of the portfolio.

You have historically kept the fund highly weighted in biotechs.

I still am and I am suffering for it in the short term. I still think biotechs are where the most money is from today's level. The fund has some 35% in biotechs and about 12% in tools, which behave similar to biotech stocks as they are technology-oriented, dealing with things such as gene chips and gene sequencing machines. It's an industry which feeds off research and development spending. We think this is is a tremendous growth sector and an industry we are particularly interested in.

Unlike biotechs, these companies are not developing therapeutic products and their business models are more traditional. They have sales and profits, yet they are going down alongside technology companies. Biotechs have been crushed by the market and the risk is that sentiment will stay depressed for a while.

When do you think the market will recover and biotech valuations come back from their lows?

They say that the hangover has a direct correlation to the binge. In biotech there was a big binge but it was a short one lasting from October 1999 to March 2000. During that time, the average biotech quadrupled. While they were foolishly low at the start of the rise, they were foolishly overvalued in a short period of time but the run up was not as prolonged as with technology.

When we thought biotechs were overvalued in first quarter 2000 we started taking money out of the sector and putting it back into companies such as Cardinal Health, a few HMOs and a few large drug companies, which were considered more defensive. We did this again in October 2000 but not enough. Today, with the recent falls in stocks, I am not at all tempted to move the portfolio to a more defensive position. Biotechs are starting to look really cheap and the cheaper they get the sharper the rally.

How much exposure do you have to the more traditional drug companies?

I've never had much exposure to big drugs in this portfolio as we tend to look for companies that offer 20%+ growth rates. We do own four large US firms such as Pharmacia and Pfizer, but we do not own UK stocks such as GlaxoSmithKline.

In the UK, I look more at stocks such as Galen and Shire which have higher growth rates because they are coming from a smaller base. They do not need blockbuster products to grow, whereas big drug companies have to have two to three a year just to keep going.

The big companies are also on the verge of going through patent expirations, so it will be more difficult for them to sustain their growth rates.

What do you look for when looking at potential investments?

There are a lot of varying business models in this sector. For drug companies we use all the traditional models, price to earnings ratios, Pegs and the like. On other companies in the sector this is more difficult as they do not yet have profits or on the verge or making profits.

For stocks such as that, traditional valuation models would see some companies on sky-high P/E's. Instead, if you look forward to what the earnings may be in, say, 2004 and discount it back, it appears to be on a more reasonable rate.

For both drug companies and biotechs we are also very focused on the pipeline, looking at what they will be producing in the next year or two which will enable them to grow. It is the key differential in investments. All the drug companies we hold have a good pipeline.

Look at Millennium Pharmaceuticals, it has a market cap of $5.6bn and is not making any profits at this point, yet it is considered an attractive stock. In the past few months, it has hit a high of $89 a share but now it is down to about $26 and yet there has been no bad news and the company has recently signed a $250m deal with Abbott Laboratories.

The barriers to entry in this field are high and patents are quite important, that is what differentiates these companies from straight technology companies.

With 80% of the fund invested in the US and 20% in Europe, how do you analyse the funds from your London base, and how many work on the portfolio?

We are very bottom-up driven and with the mid to small cap orientation of the fund it is important we have a good relationship with the companies we invest in.

The universe for healthcare is huge, with more than 1,000 firms in the US alone. Deane Donnigan, who used to be a clinical pharmacist, works on the fund with me, and travels to the US quite often to visit the companies. At the same time many of the companies also visit us so it is not hard to run the portfolio from a London base.

While there are just the two of us at the moment, we are looking to expand the team within the next 12 months. We may look to double the staff as a minimum. My retirement is not out of the question.

I'm not going to work forever but there are no immediate plans for me to step down. Still, that is not the only reason to increase the staff. At one point we were running $1.4bn in healthcare money. That is a lot of work for just two people.

In such a volatile sector, what kind of risk controls do you take with investments in the fund?

Mainly I own a lot of stocks, 160, so that is how I spread the risk. The biotech portion of the fund is more diversified than the drugs or services portion. It depends on the risk profile of the individual company, but most of the biotechs would have weightings of about 0.5%.

However, weightings in individual stocks are not typically higher than 1.5%, although last year we did have 2% in Cardinal Health. The top 10 in the fund makes up only 12% of the entire portfolio.

Not only does this limit the risk but I have always preferred to run a portfolio in this way. Besides, there are a lot of firms in the sector that we find interesting and that we want exposure to.

The holding period within the fund also tends to be long. I do not buy stocks thinking they will be up next month. The orientation is long but last year we were very active due to the high volatility in the market. Typically, the turnover is low, but last year it was higher than normal as a result of this volatility.

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