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WALL STREET, CALIFORNIA | MANAGER'S FORUM

Scientific Method

For biotech and health-care fund manager, buying decisions are a matter of thorough investigation.

March 25, 1997

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?

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