3rd Quarter Stock Preview: Wanted: Inflows

The convergence of negative milestones and dour overall market conditions led mutual fund dollars to flee speculative growth stocks, including biotech, last quarter. The results weren't pretty: money flows were negative in healthcare/biotech mutual funds 12 out of 13 weeks in the quarter, and the BioCentury 100 Index posted a quarterly double-digit percentage decline for only the second time since the bottom - and end - of the bear market in March 2003.

Given those numbers, biotech buysiders are divided on what the rest of the year holds. One camp maintains that a biotech updraft won't happen in a vacuum and requires a turnaround in macro conditions. The other group is less concerned with the macro climate and thinks biotech might be able to dig its own way out of the red. Those buysiders see value plays across biotechs of all sizes. Many expect that large, profitable biotech companies may lead a charge in the second half, driven by strong second quarter financial results throughout July.

On the financing front, neither group sees much happening until the fall.

Half off

As biotech rounds the halfway mark on the year, there's a considerable amount of red across the board. The second quarter erased all of the group's first quarter gains, as the BioCentury 100 Index fell 10% and is now down 4% on the year. The sell-off was spread over the entire spectrum of market caps, as each valuation band posted a drop of 5% or worse (see "Results by Market Cap").

Broad market factors clearly were at work, as the NASDAQ and S&P 500 were also down 7% and 2%, respectively, in the second quarter. However, a closer look shows the BioCentury 100 was on the decline well before the NASDAQ.

For the six weeks starting in mid-March, the BioCentury 100 fell 6%, while the NASDAQ added 1%. In that period, the sector was riddled with negative clinical and regulatory news in the mid-cap group (see "Tracking the Decline," A3).

Perhaps not surprisingly, April saw $945.3 million in net cash flow out of healthcare mutual funds, according to the Investment Company Institute, an association of U.S. investment companies. That was the largest exodus of money from healthcare mutual funds since July 2002, when $1.1 billion left the space. Moreover, the overall flow of funds was positive in April, with $26.4 billion moving into all equity-based mutual funds.

"As the manager of a biotech fund, I can certainly confirm that flows have been negative," said Evan McCulloch of Franklin Templeton. "A bunch of negative binary events is tough on dedicated biotech investors and even harder on generalists - where else do you lose 60% in one day?" he said.

"Every time you have a slew of negative binary events, you see another tier of generalists say 'forget it.' Then you're back to the

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