Small-cap biotech is regarded as an area of the market with one of the most extreme risk/reward trade-offs. Either a company strikes it lucky with a treatment or process and its valuation rockets, or it fails to bring anything to market, burns through cash and eventually becomes worthless. 
However, while this binary set of outcomes makes small-scale biotech extremely risky, many fund managers regard it as one of the most exciting areas for long-term growth, capable of changing the way we treat diseases and vastly lengthening life expectancies. So how then can they access the long-term growth opportunities without exposing their investors to unnecessary risks?
For Tim Crockford, manager of the Hermes Europe ex UK Equity and Hermes Impact Opportunities Equity funds, the solution is to avoid the companies that carry out diagnostics and develop new drugs and treatments, focusing instead on those that supply the equipment for these activities.
“The fact is that this space [biotech] is going to be much larger five or 10 years down the road,” he explained.
“We don’t know who the winners and losers are going to be on the downstream side, but we can make very safe bets on who the winners and losers will be on the upstream part of the value chain, where the space is much less fragmented and very much dominated by some mid-size players that – we think – are all going to be beneficiaries.”
One of the companies Crockford is particularly excited about is British firm Abcam, which he described as “kind of the Amazon of the antibody world”. The manager holds the stock in his Hermes Impact Opportunities Equity fund and says he would hold it in his European fund as well if the mandate allowed it.
To provide some background to what the company does, Crockford explained that the foundation of a biological drug is a protein, which is mass-produced into large quantities. When you move up the value chain towards the drug discovery space – where new molecules and proteins are being discovered that could eventually be transformed into biological drugs – the proteins that the research is based on must have particular characteristics.
“And that’s how Abcam started,” he continued. “It started off as a website to serve as an online retailer and logistics chain for these particular antibodies and proteins that were delivered to the labs that were researching these new drugs.
“Of course, one of the byproducts or offshoots of that was that, like Amazon, you would have researchers going online and writing reviews on which of these antibodies or proteins were successful in achieving the end points they were trying to get to and which ones weren’t.
“So, what this meant was that, over time, this company built up this huge database of knowledge which has made it one of the market leaders in this space.”
Abcam has diversified since then and has recently moved into the direct production of biotechnological products. Crockford said that one of the most promising growth avenues for the company in particular is the Abcam Inside programme, through which it has developed an antibody range called RabMAbs, or rabbit monoclonal antibodies.
“Without getting too technical and going into why that is, these antibodies have consistently shown they have the attributes that researchers require,” he added.
“And what Abcam is now doing is striking deals with the biotech and pharmaceutical companies that are discovering and researching these drugs, and it will start to share in the future revenues of these drugs should they be successful. This is a very exciting future driver of revenues and earnings for this company.”
Crockford is not the only one who is optimistic about the prospects for Abcam. Data from FE Analytics shows 15 funds in the IA universe hold the stock in their top-10, including Standard Life UK Smaller Companies, Marlborough UK Multi-Cap Growth and Ardevora UK Equity.
FE Alpha Manager Jeremy Lang, who runs the Ardevora fund, tipped Abcam as his stock to watch at the start of the year.
He described it is an “unusual company”, adding that its rapid growth, lack of comparable peers, and changing and highly specialised nature made it difficult for analysts and investors to value. However, he said he has been reassured by its management’s clear and consistent plans for the business.
“Current investment is being made to ensure the company has the best possible chance of taking advantage of the significant growth opportunities that lie ahead,” he explained.
“The company is lucky to have these opportunities in a world where growth is hard to come by. For investors who are prepared to look forwards rather than backwards, we think patience will be well rewarded.”
Data from FE Analytics shows Hermes Impact Opportunities Equity has made 13.51 per cent since launch in December last year, more than twice the gains of its MSCI AC World benchmark and IA Global sector, although this time period is too short to draw any meaningful conclusions about performance.
The $167.1m fund has ongoing charges of 0.95 per cent.
Hermes Europe ex UK Equity has made 62.07 per cent since Crockford took full control at the start of 2015, compared with 47.99 per cent from its IA Europe ex UK sector and 46.76 per cent from its FTSE World Europe ex UK benchmark.
Performance of fund vs sector and index under manager tenure
Source: FE Analytics
The fund is £175.2m in size and has ongoing charges of 1.64 per cent.