Next Edge Bio-Tech Plus Fund: Commentary

FUND COMMENTARY – December 2017

THE YEAR THAT WAS:

2017 saw biotech and healthcare join the bull market, after sitting out 2015 and 2016.  The recovery is complete and 2018 holds many positives for the sector not seen in many years which paves the way for the likelyhood continued strong returns. 2017 was a breakthrough year for novel biotechnologies such as Car-T and gene therapy, and it’s only just the beginning. 

The sector remains among the most underinvested in the market. The FDA issued the most approvals in 20 years, and tax reform will likely unleash a mergers and acquisition (“M&A”) wave that lay dormant in 2017. Already in the opening weeks of 2018, we are beginning to see this. Furthermore, the strong Euro and Yen also incentivizes European and Japanese big pharma to join the buying spree. While we benefited significantly from M&A in 2016, despite the sector being sharply lower, M&A declined sharply during 2017.

Adding to the momentum, many of our holdings crossed the divide from clinical development to commercial companies when they received FDA Approval.

Entering 2017 we knew one thing with certainty: that the number of therapeutics winning FDA approval would rebound sharply from 2016’s abysmal total of 22. The new FDA, under Scott Gottlieb, has been friendlier to innovation than I have ever seen. Approvals are often coming weeks or even months early, to the point that 2017 saw the most approvals in 20 years.

THE YEAR AHEAD:  M&A WAR CHEST BEING PUT TO WORK

Sector M&A fell to the lowest level in years in 2017 as the market waited for tax reform to be effected. We expect it to once again play a significant role in our 2018 returns, separate from what markets do, as it did during 2016. The fuel for the M&A wave is a war chest of balance sheet resources, compounded by slowing growth of big BioPharma, amplified by a persistent worsening of R&D productivity.  Companies we hold in the Fund’s portfolio have often been favoured in acquisitions because they:

1. Have overcome most of the onerous and costly clinical hurdles;

2. Are expected to grow revenues rapidly, with pricing power;

3. Be the best-in-class therapeutic with favourable FDA labeling for their indication;

4. Are the innovators of their therapeutic; and
5. Possess a drug discovery platform that could yield additional future therapeutics.

A PORTFOLIO POISED TO DELIVER BREAKTHROUGH THERAPEUTICS IN 2018:

This year will be filled with potentially transformative data readouts and FDA decisions impacting many of our investments. Our farm system continues to foster many of our holdings maturing into commercial growth companies with breakthrough products.

CHANGING THE RULES IN THE MIDDLE OF THE GAME

For December, the Next Edge Bio-Tech Plus Fund (“the Fund”) Class A Units declined -0.94% while the Class F Units declined -0.86%, vs the Fund’s Benchmark return of +8.58%, driven by a +24% pot fuelled advance (WEED) in the TSX Healthcare Index (^TTHC). For the past 12 months, the Class A Units and Class F Units advanced +13.74% and +13.08% respectively versus an increase of +26.51% for the Fund’s Benchmark.

After exceeding the Fund’s Benchmark (60% NBI / 40% ^TTHC) consistently over most of the 3 years since the Fund’s inception, the TSX added two pot stocks to the TSX Healthcare Index (^TTHC). Canopy Growth-WEED and Aphria Inc-APH.  While their products were, until recent years, the domain of illegal basement grow-ops, these companies have successfully draped themselves in the cloak of being ‘medical’ companies. As these pots stocks went parabolic in November-December, gripped by a retail mania, the effect on the TSX Healthcare Index, (^TTHC) obliterated that hard-earned outperformance. 

Being ‘healthcare’ companies, naturally their products will be competing with Liquor and Tobacco for the marginal vice dollar. Curiously, these ‘healthcare’ companies are not generally covered by healthcare analysts, but by Consumer Product and Special Situations analysts. Admittedly this is sour grapes on my part.

The effect has been so profound that the pot stocks lifted the TSX Healthcare index to a +24% gain in December alone, in contrast to the modest +1.47% gain for the Nasdaq Biotech index, a better reflection of our mandate.

Being ‘healthcare’ companies, naturally, their products will be competing with liquor and tobacco for the marginal vice dollar. Curiously, these ‘healthcare’ companies are not generally covered by healthcare analysts, but by Consumer Product and Special Situations analysts. Admittedly, this is sour grapes on my part.

The effect has been so profound that the pot stocks lifted the TSX Healthcare Index (^TTHC) to a +24% gain in December alone, in contrast to the modest +1.47% gain for the Nasdaq Biotech Index (NBI), a better reflection of our Fund’s mandate.

BIOTECH UNDERVALUED ENTERING 2018:

A measure of the relative P-E multiple of the S&P Biotech Index to the P-E Multiple of the S&P 500 indicates the sector is at a threshold only seen at the lows of 1994, 1997, 2010 and 2016. In a richly valued market, it remains one of the few undervalued sectors for which the storm clouds of the past few years are receding.

Typically, coming off bear market lows, such as it did in spring 2016, witnesses the percent of NBI companies above their 200-DMA achieve readings of 80% before a pause. Biotech breadth has been consolidating for 18 months between readings of 40% to 60%. It may have stored sufficient potential energy to thrust up to a reading of 80% in 2018. The pieces are definitely lining up.

How quickly a year has passed. It is time again when your the Next Edge Bio-Tech Plus Fund will host ‘Biotech Alley’, thanks to the generosity of the Cantech folk.  Look for us on January 31st, 2018 at the Metro Convention Centre. The conference features innovative Canadian growth companies in technology and healthcare, and feature speakers.  Our inaugural panel discussion was greeted by a packed house.

We will make free tickets available for the asking to our Investment Advisor friends, their associates and clients who may have an interest. You will meet the management of some of our key holdings and participate in a spirited panel discussion among company CEOs and industry experts.

Link to Cantech 2018 Conference Site

INTERVIEW FOR THE CANTECH LETTER JANUARY 2018:

Here is the recent interview conducted with The Cantech Letter in advance of the upcoming event: Three Canadian Biotech Stock Picks from Next Edge Capital’s Eden Rahim

Composition of Holdings for December 29th, 2017

Reflecting the unchanged performance of the Fund’s portfolio during December, the allocation between Foreign, Canadian holdings and Cash was also unchanged.

 

 

1. Next Edge Bio-Tech Plus Fund returns are net of all fees and expenses associated with Class A Units charged from May 1st, 2015. Next Edge Bio-Tech Plus Fund returns are net of all fees and expenses associated with Class A1 Units, Class F Units, and Class F1 Units charged from March 1st, 2015. The historical annualized rates of return for December 29th, 2017 for Class A are 1 yr 13.74%, 3 yr – N/A, 5 yr – N/A, 10 yr – N/A, CARR 0.75%; for Class A1 are 1 yr 13.20%, 3 yr – N/A, 5 yr – N/A, 10 yr – N/A, CARR 2.84%; for Class F are 1 yr 13.08%, 3 yr – N/A, 5 yr – N/A, 10 yr – N/A, CARR 2.60%; for Class F1 are 1 yr 13.70%, 3 yr – N/A, 5 yr – N/A, 10 yr – N/A, CARR 3.67%.
2. The Benchmark for the Next Edge Bio-Tech Plus Fund is:
(i) 40% of the percentage gain or loss of the S&P/TSX Capped Health Care Index; plus
(ii) 60% of the percentage gain or loss of the NASDAQ Biotechnology Index
The Benchmark returns are unaudited and subject to final confirmation. The historical annualized rates of return for the Benchmark for December 29th, 2017 are 1 yr 26.51%, 3 yr – N/A, 5 yr – N/A, 10 yr – N/A, CARR -2.65%.
3. Part Year
* Part Month start date April 13th, 2015 to April 30th, 2015
** Part Month start date: February 17th, 2015 to Feb 27th, 2015.
There are inherent limitations in any comparison between a managed portfolio and a passive index. Each index is unmanaged and does not incur management fees, transaction costs or other expenses associated with a private fund. There are risks inherent in hedge fund investing programs.
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