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Fidelity® Select Biotechnology Portfolio

  • Symbol: FBIOX
  • No Transaction Fee No Transaction Fee 1
  • Fidelity Fund Pick Fidelity Fund Pick
  • Quarterly Fund Review
Select Biotechnology Portfolio: Quarterly Fund Review
MARCH 31, 2015
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Investment Approach

  • Fidelity® Select Biotechnology Portfolio is an industry-based, equity-focused strategy that seeks to outperform its benchmark through active management.
  • Fundamental, bottom-up research leveraging Fidelity's experienced global health care team is the primary source of idea generation. Our analysis is driven by a data and statistical approach that places an emphasis on valuation through free cash flow and the probability risk-adjusted net present value of future earnings, the standard valuation method in the drug-development industry.
  • Our investment approach includes evaluating a company's drug pipeline, the size of its market opportunity and its relative valuation. We position the fund around four major themes: long-term winners with strong product pipelines - our primary focus - turnaround situations, breakthrough innovations and early-stage firms with promising science.
  • Sector strategies could be used by investors as alternatives to individual stocks for either tactical- or strategic-allocation purposes.

Market Review

For the three months ending March 31, 2015, the biotechnology industry returned 11.87%, as measured by the MSCI U.S. IMI Biotechnology 25-50 Index, significantly outperforming the broadly based S&P 500® Index, which returned 0.95%.

The industry's outperformance for the quarter was primarily driven by high double-digit returns from mid-sized companies. Promising science and merger and acquisition (M&A) activity continue to propel the industry's outperformance. AbbVie's announcement that it was purchasing Pharmacyclics highlighted the M&A trend that saw larger pharmaceuticals companies buying smaller firms to enhance their product pipelines. Thanks in part to the acquisition announcement, shares of Pharmacyclics more than doubled during the quarter.

Among large-cap firms, Biogen posted the strongest results over the quarter. Shares of Biogen, formerly Biogen Idec and known for its drugs to treat multiple sclerosis, gained roughly 24% this quarter on positive developments. In January, the company reported quarterly revenue of $2.6 billion, with adjusted earnings per share up 74% from a year ago and well ahead of expectations. In February, Biogen acquired U.K.-based Convergence Pharmaceuticals and its promising neuropathic pain candidate. The company followed up in late March with encouraging phase 1b results for its treatment for Alzheimer's disease; Biogen's aducanumab compound targets amyloid plaques in the brain, a research area where dozens of competitors have failed.

Ongoing innovation, underscored by a string of new drug approvals, low interest rates, and new entrants into the industry continued to act as a tailwind for biotech.

Performance Review

During the first quarter, the fund easily outpaced its benchmark, the MSCI U.S. IMI Biotechnology 25-50 Index. Strong stock selection drove the fund's outperformance. A sizable underweighting in Amgen was the largest individual contributor for the period. The global biotechnology pioneer endured investor ambivalence this period, its shares up just 1% after a choppy quarter. Positives included demand-driven, above-consensus earnings; an above-market dividend yield; and a packed prospect pipeline. But after a long stretch of strong stock performance, some worried Amgen was shifting to a late-stage, slow-growth company, while others questioned its valuation and debt metrics. More generally, bears have expressed concern of a "biotech bubble": industry returns have topped sector rankings coming up on an unprecedented five years in a row.

An overweighting in Intercept Pharmaceuticals also helped. Shares of the development-stage biotechnology innovator, which focuses on treating liver conditions such as nonalcoholic steatohepatitis (NASH), gained 81% this quarter. According to the Mayo Clinic, liver disease may affect up to a quarter of American adults and is expected to soon surpass hepatitis C as the leading cause of liver transplants. In January, Intercept announced that its investigational obeticholic acid (OCA) product had received "breakthrough therapy designation" from the U.S. Food and Drug Administration for NASH patients with liver fibrosis, for which no approved treatment currently exists. OCA is in trials for several other applications as well.

Hurting relative results was our overweightings in small-cap stocks Karyopharm Therapeutics and Acorda Therapeutics, both of which fell by roughly 18% for the quarter. These stocks aligned with our investment approach due to Karyopharm's promising data and Acorda's strong competitive position.

Holding Market Segment Average Relative Weight Relative Contribution (basis points)*
Amgen, Inc. Biotechnology -11.34% 136
Intercept Pharmaceuticals, Inc. Biotechnology 1.40% 78
Horizon Pharma PLC Pharmaceuticals 0.85% 61
Gilead Sciences, Inc. Biotechnology -8.83% 59
Esperion Therapeutics, Inc. Biotechnology 0.60% 47
* 1 basis point = 0.01%.
Holding Market Segment Average Relative Weight Relative Contribution (basis points)*
Acorda Therapeutics, Inc. Biotechnology 0.77% -27
Karyopharm Therapeutics, Inc. Biotechnology 0.29% -16
Opko Health, Inc. Biotechnology -0.45% -13
Ardelyx, Inc. Biotechnology 0.23% -12
Prothena Corp. PLC Biotechnology -0.15% -11
* 1 basis point = 0.01%.

Outlook and Positioning

While we anticipate volatility in the industry, we maintain a positive outlook on drug development in biotechnology over the next three to five years. We believe reasons for a rich pipeline of drugs in clinical development include: advances in basic research, advances in diagnostic tools, improved access to capital and increased outsourcing of research and development by large pharmaceuticals companies.

We believe a tremendous amount of innovation continues to occur in the biotechnology industry, which has led to a robust pipeline of potential new drugs. While it can take years to get a drug from initial investment to commercial launch, we believe the post-approval stage is one of the most attractive investment points in the drug development cycle, because all the research-and-development costs have been expensed during the course of development. This strong pipeline means that innovation should remain a source of investment opportunity in 2015 and beyond. The price appreciation of biotech stocks has outpaced the broader market in recent years.  At the same time, the earnings of these companies have accelerated as well, thanks in part to new product cycles.  Valuations should be looked at on a case-by-case basis. We believe valuation is important and the net present value of future cash flows should justify the price an investor pays for a stock.

Clinical failures or setbacks remain a primary risk to individual biotech stocks. The success rate of new-drug development has not improved materially during the past decade.

At the industry level, reimbursement pressure is another headwind. As biotechnology drugs become a larger part of health care solutions, we expect government and insurance-company scrutiny to increase. We favor companies with drugs that enjoy little-to- no competition and that focus on unmet medical needs, so reimbursement pressures can remain manageable.

We remain generally optimistic on large-cap biotechs owing to reasonable valuations, new product cycles, undervalued pipelines and low Wall Street estimates on forward earnings. As the bigger pharmaceutical companies go through patent expirations, we continue to view the larger biotech companies as more attractive acquisition targets. We remain selective on the small- and mid-cap names, where we see high return dispersion and idiosyncratic risk.

The fund favors companies that are addressing unmet medical needs through biologics. We take a statistical approach, using bottom-up fundamental research driven by data and statistics over a scientific approach in the biotechnology industry. Given the volatile aspect of the industry, we look to manage risk in a number of ways. We pay close attention to the valuation of individual names and the fund seeks a quality bias, looking for stocks that we believe have the highest chance of success based on fundamental analysis. At period end, the fund continued to hold more than 200 stocks and sought to emphasize larger companies with positive cash flows, as they tend to exhibit more stable earnings growth and have diversified product line-ups.

1. No Transaction Fee Fidelity funds are available without paying a trading fee to Fidelity or a sales load to the fund. However, the fund may charge a short-term trading or redemption fee to protect the interests of long-term shareholders of the fund. Shares are subject to the fund's management and operating expenses. See Expenses & Fees for more information.

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