IF INTERNET FUNDS ARE TOO BORING, TAKE ANOTHER GANDER AT BIOTECH: MAGIC WORD FOR BOTH IS, NATCH ‘POTENTIAL.’ PROFITS? DON’T ASK

Question: where can investors buy mutual funds that invest in emerging technology companies, most of which are posting losses with barely any revenue? If you answered Internet funds, you’re correct. If you answered biotech funds, you’re also correct.

Despite the biotech industry’s extreme volatility — as evidenced most notably in 1992 when their valuation sank like a stone — some fund managers see investors as more willing than ever to gamble on it because of their frenetic demand for Internet companies.

“Investors’ interest in the Internet demonstrates foresight,” says Faraz Naqvi, who manages the $6 million Dresdner RCM Biotechnology Fund, launched in February 1998. More to the point, he says, “It shows they are willing to take a leap based on a company’s potential; it’s a good sign for biotech companies.”

Recent growth in the number of funds with biotech holdings suggests that Mr. Naqvi isn’t alone. There are just six pure biotechnology funds but fully 52 biotech-related funds at present, compared with only 19 at 1994’s end, according to Lipper Inc., the New York fund researcher. Lipper includes as biotech any health care funds with considerable biotech holdings.

Two funds — Monument’s Medical Sciences Fund and Kinetic Holdings’ Medical Fund and Cure for Cancer, which holds only companies engaged exclusively in cancer research — have been launched in the last couple of weeks alone.

“Biotechnology is just an extension of what we’ve been doing –investing in things that improve peoples’ standard of life,” says Alex Cheung, manager of the high-flying Monument Internet fund as well as Medical Sciences.

more than twofold growth

All told, the biotechnology sector has grown even faster than the number of funds tracking Standard & Poor’s 500 stock index. At the end of 1994, there were 44 such funds; today there are 105, according to Lipper.

“It’s not surprising,” says Anne Ruff, lead portfolio manager of the year-old, $60 million Rydex Biotechnology Fund, whose year-to-date return of 11.1% ranks it No. 1 among pure biotech funds.

“Investors no longer believe they can put all of their eggs into the Internet basket and perform well,” she says. “Biotech gives them something else to look at.”

Choosing the right fund is another thing altogether, however.

The first problem is distinguishing whether you are buying into a fund that’s betting on new technologies or one that’s relying more heavily on established biotech firms, like the pharmaceutical giants.

The safest bet, says Emily Hall, a stock analyst at Morningstar Inc., are those funds heavily weighted toward large-cap stocks, like, say, Amgen Inc. or Genentech Inc.

One example is the $820 million Fidelity Select Biotechnology fund, whose median market cap is $8 billion. Year-to-date as of last Monday, it had returned 2.6%, according to Lipper. Its one-year return was 27.6%.

Franklin Biotechnology Discovery Fund, launched last year, wagers on earlier-stage, smaller-cap companies. The fund, with a median market cap of $500 million, was down -7.6% year to date and -9.5% over the same one-year period.

Liquid? They don’t even float

The problem for smaller biotech firms, suggests Scott Morrison, who directs the Palo Alto, Calif., biotech consulting arm of Ernst & Young LLP, is illiquidity.

“The ongoing consolidation of investment banks has made liquidity the name of the game. Small-caps don’t have enough float so it’s harder to get the sell-side excited about them,” he explains.

“We’re all hopeful this is a short-term issue,” he adds.

So is Dresdner’s Mr. Naqvi, whose fund invests in both large-and small-cap biotech companies and has returned 4% so far this year.

Nevertheless, says Mr. Naqvi, investors need to understand that “a lot of these stocks have stories that are pretty far out in terms of having products actually out there. They have to be willing to withstand very high variability in performance.”

If the Internet is any indication, investors may be ready for biotech again after all.