Scientific Method

L.A. Times Archives

March 25, 1997 12 AM PT

Samuel D. Isaly has racked up an impressive record investing in the health-care sector.

His Eaton Vance Worldwide Health Sciences fund, which he has managed since 1989, gained 131% in the five years ended Dec. 31, compared with 72% for the average health-care fund and 92% for the average U.S. stock fund.

Isaly typically keeps 60% to 80% of assets invested in biotech stocks and specialty health-care firms. The remaining 20% to 40% of assets are usually invested in 10 major pharmaceutical companies.

Isaly, 52, a native of Ohio, graduated from Princeton and studied at the London School of Economics as a Fulbright scholar. After working as a pharmaceutical analyst for Chase Manhattan Bank in New York, he went on to co-found Mehta and Isaly Asset Management in Boston in 1989.

“Biotech is an industry coming of age,” says Isaly. He sees further gains ahead--but not for all stocks. He’s looking increasingly overseas for innovation and value.

Morningstar, the mutual fund tracking firm, says that “the secret to this fund’s high returns and low risk . . . comes down to strict discipline. . . . Because he keeps holdings to a minimum, Isaly does extensive fundamental research before adding a stock.”

In the following interview, Isaly shared his outlook on the sector with Times contributor Susan Jaques.

Times: You clearly favor the biotech and drug sectors over medical devices and health-care delivery. Why?

Isaly: That’s what we know best. We chose to know it best because you have high returns, protected positions because of patents, and explosive demand characteristics. Although going forward, we will . . . [add more] medical services and devices, which are currently less than 5% of the fund.

We think the outlook [for biotech] is particularly powerful right now. We find that the number of profitable companies will double from 1996 to 1997 from six to 13, and by the year 2000 will reach 50.

Biotech is analogous to the electronics technology industry about the place of the introduction of personal computers 20 years ago.

Times: The debut of Dolly, the cloned sheep, has put genetic research back in the headlines. How will the news affect the biotech sector?

Isaly: On the positive side, it highlights to investors that there are new technologies and people are conquering them. On the negative side, it makes people fearful of biotech. On balance, I believe it’s positive for investors.

Times: With hundreds of biotech firms researching thousands of drugs, how do you narrow down the field for promising stocks? Describe the process you go through.

Isaly: We catalog all the drugs in development. We have about 3,000 entries. We know where they stand. We give them some probability of success and we give them a number, a value of the pipeline.

We then compare what we have to pay for it. We include options, warrants, free stock, losses, debt, cash--as if we were buying the whole company, not one share of stock. Then we compare the cost to what we get and we arrive at an investment decision.

It sounds simple, but the execution of it is not. It is not a computer-driven investment decision. We use a lot of judgment in the final selection.

Times: Does that judgment include talking to scientists?

Isaly: We talk daily to the scientists involved. Not a day goes by that one of my colleagues or I fail to speak to scientific representatives of companies.

Times: Let’s talk about individual companies. What are your favorite biotech companies now?

Isaly: Serono, Alexion and Pharmacopeia.

Serono is the world’s leader in female fertility enhancement and in our opinion the only multinational biotech company that sells its product worldwide. All the others are geographically limited. Genentech, for example, sells only in the U.S. [Serono trademarks include Pergonal and Metrodin.]

Alexion is a tiny little company in New Haven whose stock market value is less than $100 million. They are a leader in immunology and a developer of animal parts that can be transplanted into humans. Dolly is one way, and Alexion is another.

But they have no product, they have large losses, and there is a reasonable chance that their stock certificates will become wallpaper. We accept that risk as part of the portfolio--1.7% of our fund. So if we lost all our money, our investors would not unduly suffer.

Times: And Pharmacopeia?

Isaly: Pharmacopeia is a group of some of the cleverest chemists in the world. They have a means to make enormous quantities of pharmaceutical chemicals faster than anyone else in the world. In their five-year existence, they have already accounted for 10% of the cumulative pharmaceutical chemical candidates.

Times: Your biggest holding is Swiss Serum Institute. What does that company do?

Isaly: Swiss Serum is a very undervalued specialty company with powerful vaccine technology. Its largest class are travelers’ vaccines for cholera, hepatitis A and typhoid.

Times: Where do the large drug companies fit in your view of health care’s future?

Isaly: Pharmaceutical companies are the distribution dinosaurs. They create some technology by themselves but are increasingly outsourcing it to biotechs. They have the capacity for development and marketing on a worldwide scale, which small companies don’t have.

So you have a symbiotic relationship between large “dinosaurs” [drug firms] and discovery houses known as biotechs. From a stock market point of view, the pharmaceutical companies have reasonable growth rates, they are lower-risk, they do have profit and provide liquidity to the portfolio.

Times: Which are your favorite big drug stocks?

Isaly: Novartis is one of the world’s leading dinosaurs. It was formed from the combination of Ciba and Sandoz. We think it’s probably the most promising big- cap investment in the world at this time because they have powerful growth on the top line, more technology alliances by far than anyone in the industry, and they’re cutting costs with vigor. It’s Swiss-based.

Another is Sankyo, based in Tokyo. It has discovered one of the world’s leading cholesterol-reducing drugs, sold under the trademark Pravachol in the hands of Bristol-Myers Squibb. The company is also in the process of introducing an anti-diabetic.

Times: You also own Warner Lambert?

Isaly: Yes. They have two just-approved drugs, for diabetes and cholesterol reduction, and they are going to be big.

Times: What are the next blockbuster drugs?

Isaly: We are watching with great care a new diabetes treatment that may prevent Type 2 diabetes. Rezulin, now on the market to reduce blood sugar, is in large trials sponsored by the National Institutes of Health. There’s some suggestion that Rezulin will stop the disease in its track. That’s probably as dramatic as Dolly.

Times: Whose drug is it?

Isaly: It originated with Sankyo and is licensed in the U.S. to Warner Lambert and in Europe to Glaxo Wellcome. If successful, that will make it the largest-selling drug in the world.

Times: Who will reap the payoff?

Isaly: Sankyo is the discoverer. They will make the most money out of this product.

Times: What other drugs are promising?

Isaly: More things are coming in HIV protease inhibitors [for AIDS]. There are four or five companies actively involved in this area. The first commercial one was introduced by Roche; the bestseller was introduced by Merck. Abbott has one, and there are two very good ones by Agouron and Vertex.

Times: Are these on the market?

Isaly: Those [last] two are not. Agouron just got approval for its pediatric and adult forms, and Vertex is just finishing stage three and will probably get approval next year. They are very important holdings in our portfolio. We bought them at the right time and for the right reasons.

Times: What’s behind your Australian stock holdings?

Isaly: We own two stocks totaling 4% to 5% of the portfolio. Amrad is loosely characterized as a public company with the rights to most of the medical research undertaken in Australia.

And much like Agouron and Vertex, Biota’s specialty is rational drug design. They have come up with a therapy for influenza that you take after you get sick. It cuts the course of the disorder from a week to two or three days.

Times: Is this therapy on the market?

Isaly: No, it’s entering phase three trials in the hands of Glaxo Wellcome.

Times: There’s an intense race among biotech and pharmaceutical firms for anti-obesity treatments. Who’s close to the finish line?

Isaly: Orlistat is a new drug coming out of Roche, for people with body mass index of 25 or more, that inhibits absorption of ingested fat. It has a rather gentle effect on weight loss and is indicated for maintenance of weight loss. That is, it can be taken for long periods of time.

Amgen is in human trials with leptin. In molecular biology terms, the obesity gene we all have codes for leptin. It makes the body produce the protein leptin. The theory is that by increasing leptin, people will [lose weight because they] become satiated at a lower body mass index.

Times: You’ve weathered many storms in the health industry--from troubled HMOs and drug stocks to the biotech crash. What did you learn from the tough times?

Isaly: To be spread out around the world. Don’t be exposed to only one market. That protects you.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

EV Worldwide Health Sciences Fund

Strategy: Seeks long-term capital growth by investing in a portfolio of health science companies, including biotechnology, diagnostics, managed health care, medical equipment and supplies, and pharmaceuticals.

VITAL STATISTICS

EV year-to-date return: +2.7%

Avg. health/biotech fund return, YTD: +2.6

EV 1996 return: +18.4

Avg. health/biotech fund, 1996 return: +13.4

Avg. general stock fund, 1996 return: +19.5

EV five-year total return (1991-96): +131.0

Avg. health/biotech fund (1991-96): +72.2

Avg. general stock fund (1991-96): +91.8

Five biggest holdings as of Dec. 31:

1. Swiss Serum Institute 2. Serono 3. Novartis 4. Cento Care 5. Eisai

Sales charge: 4.75% Assets: $95 million