International Biotechnology Trust (IBT) 22 sept 2003 Page 6
INVESTMENT ADVISERS REVIEW
SUMMARY
Investor sentiment regarding the biotech sector is much improved since the last Annual
Report. The biotech market has rallied significantly and the recent approvals and strong
clinical data underscore the progress that the industry is making in bringing new drugs to
market. A reflection of this positive sentiment is the recent improvement in the share price
and NAV of IBT and the filing of three unquoted portfolio companies to try and go public if the
initial public offering (IPO) window opens.
REVIEW
2002 was a difficult year for the biotech sector. Share prices were driven lower by the overall
bear market, impending war in Iraq and a lack of appetite for risk. This led to a flight to quality
and a lack of interest in the more volatile sectors including biotech. Newsflow from biotech
companies was poor with corporate scandals and a number of drug candidate failures, which
resulted in a heightened sensitivity of investors to the risks of clinical development.
Smaller companies were hit the hardest in the sell off, which impacted the performance of
IBT given its investment focus in this area. Many smaller companies were left trading below
cash and some were delisted from the NASDAQ market, including one of IBT's portfolio
investments, Essential Therapeutics.
The NASDAQ Biotech Index (NBI) bottomed at just over 400 in July 2002. At the time of
writing the index had reached 798, a near doubling in dollar terms since the lows of 2002.
This compares with the peak in the market in March 2000 when the index reached over
1600.
There have been a number of drivers of the recovery in the sector. Removal of the
uncertainty around the conflict in Iraq, an increased appetite for risk and a broad bullish
market direction have rewarded higher beta groups such as biotech and technology.
However, the rally has not only been driven by improving general sentiment, but also by
strengthening industry fundamentals. The NBI has significantly outperformed both the
general market, rising by 48.1% in sterling terms, in comparison with rises of 8.1% in the
S&P500 Index and 35.2% in NASDAQ Composite Index (which gives a reflection of the
performance of technology stocks) during the year under review.
The initial rebound in biotech share prices was led by the large cap, profitable companies.
However investor interest has extended beyond these limited names and into the smaller
and earlier stage companies, which had suffered the most in the flight to liquidity of the
previous years. The breadth of the recent rally has been notable as previous post-bubble
rallies have been limited to the top tier of stocks. This has benefited the performance of IBT
with some of the smaller cap holdings rising sharply in the year under review, for example
Targeted Genetics which almost tripled in price. However, as noted in the Chairman's
statement, the small caps still underperformed their larger peers in the year under review
with the Merrill Lynch Small Cap Biotech Index (MLSCI) rising 26.5% in sterling terms in
comparison with a 48.1% rise in the NBI.
The rally has been underpinned by the release of better than anticipated earnings by a
number of large, profitable biotech companies, with sales of approved products going
strongly. While earnings growth may be an issue in the pharmaceutical sector, biotech
companies continue to post strong results with a number of companies recently moving into
profitability.
Positive sentiment around the regulatory environment has also drawn interest to the sector.
In contrast to the relatively low expectations following the disappointments of 2002, there
