Mollified by mid-caps

Fund managers are looking to 2008 with more optimism than one might expect from people who saw their portfolios struggle against the benchmarks last year. While some of the optimism may be associated with 2008 not being 2007 and its attendant macroeconomic crises, buysiders are seeing investment opportunities, particularly in the $500 million to $2 billion mid-cap space.

Even though more money was invested in the global biotech sector in 2007 than in any year except 2000 - and in the case of Europe it was the best ever fundraising year for biotechs - investors had a particularly disappointing second half.

The performances of a few key top tier biotechs masked what is going on with the small caps. For the year, the BioCentury 100 index jumped 12%, outperforming the general markets and other key indices. The price-weighted BioCentury benchmark was driven by strong moves from high price per share companies. Of the 60 companies in the index that ended the year priced at $10 or more per share, 41 were up and 19 were down in 2007.

Other biotech benchmarks did not perform as well. The modified market cap-weighted NASDAQ Biotechnology and the equal dollar-weighted AMEX Biotech (BTK) indexes were up 5% and 4%, respectively. But the group still outpaced big pharmaceuticals, as the market cap-weighted Amex Pharma index was down 1% on the year despite a 33% gain by Merck & Co. Inc.

By contrast, the small and micro-cap names were off 24% and 29% on a median basis, while the European space was similarly hit. The market cap-weighted BioCentury Europe, which is made up of mid-cap and small cap stocks, was down 18% while the BioCentury London index, which is inhabited mostly by small cap to microcap stocks, was down 34% (see "Index Performance," A20).

By year end there were 39 companies with market caps above $2 billion, up from the 33 at the end of 2006. Ten companies were promoted to the $2 billion-plus tier, including Onyx Pharmaceuticals Inc. which jumped from the small cap to the large cap tier.

The departures included M&A takeouts of MedImmune Inc., Serono S.A. and Icos Corp. Only Idexx Laboratories Inc. fell from the top tier.

The number of companies in the mid-cap $500 million to $2 billion tier fell from 80 at the end of 2006 to 72 at the end of last year. In 2007, in addition to Idexx dropping down a tier, 18 companies were promoted to the mid-cap tier, and a further five joined the group as IPO debutantes.

Eight of the 2006 group were promoted to the $2 billion plus tier, six companies were acquired and 17 were relegated to a lower echelon.

Probably the biggest challenge for investors in 2008 will be to identify those companies that will take up the mantle held by Genentech Inc.. and Amgen Inc., two companies that used to combine safety and high growth, but that some buysiders believe are in danger of slowing to the pace of big pharma.

Meanwhile, no one really expects the market to be any less tough on smaller companies in 2008 than it was in 2007, although one or two companies with anticipated product launches are still catching the eye of buysiders.

The consensus is that generalists have withdrawn - not just from biotech, but from healthcare in general - in the belief it is no longer a defensive sector in times of market uncertainty. The credit squeeze caused by the subprime mortgage meltdown, while not directly affecting dedicated biotech funds, removed the

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