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Fidelity® Select Biotechnology Portfolio

  • Symbol: FBIOX
  • No Transaction Fee No Transaction Fee 1
  • Fidelity Fund Pick Fidelity Fund Pick  2
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Fidelity® Select Biotechnology Portfolio: Quarterly Fund Review
MARCH 31, 2016
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Market Review

For the three months ending March 31, 2016, biotechnology stocks, as measured by the MSCI U.S. IMI Biotechnology 25/50 Index, returned -18.24%, considerably behind the 1.35% gain of the broadly based S&P 500® index.

Biotechnology stocks were hit hard in January virtually across the board, with development-stage companies experiencing the most pronounced share-price weakness. Negative clinical and regulatory developments directly affecting several companies weighed on the entire group and, coupled with generally fearful investor sentiment, dragged down the stocks of companies with weak and strong fundamentals alike. Even the shares of blue-chip biotechs such as Amgen (-7%), Gilead Sciences (-9%) and Celgene (-16%) suffered losses. AbbVie, with a -3% return, emerged relatively unscathed.

The broader market generally moved in tandem with the price of crude oil, which fell early on but rallied later in the quarter on hopes that energy producers might rein in production. However, biotechnology stocks barely participated in the broader market's recovery from mid-February onward. Partly, this might have been due to investors' preference this quarter for defensive stocks with high dividend yields, as evidenced by the strong outperformance of the telecommunication services and utilities sectors. Investors also might have been cautious about biotech stocks with the presidential primary season heating up, and in the wake of last fall's slide in the group following a remark by one of the candidates about price gouging.

Adding to investors' concerns at the start of 2016 was fear of slowing global and domestic economic growth, the latter underscored by initial estimates that U.S. GDP (gross domestic product) expanded by a disappointing 0.7% rate in the fourth quarter of 2015, well behind the 2.0% rate of the third quarter and the robust 3.9% pace of the second quarter. ■

Performance Review

For the quarter, the fund returned -28.45%, well behind the MSCI U.S. IMI Biotechnology 25/50 Index. Versus the MSCI index, the fund's underperformance was largely traceable to lighter-than-benchmark weightings in the shares of the largest, most financially stable biotech companies, which held up better than their smaller-cap peers. Examples of industry leaders in the index that hurt because we didn't own them or underweighted them were AbbVie, the fund's largest relative detractor, Amgen and Gilead Sciences.

At the same time, it hurt to overweight smaller firms that investors shunned amid greater market volatility and growing recession fears. As a reminder, we believe smaller companies typically offer the best opportunities for identifying undiscovered value through the kind of comprehensive research Fidelity brings to bear.

Having no allocation to hemophilia specialist and index stock Baxalta also worked against us, as the stock was one of a relative few in the biotechnology group to post a small gain for the first quarter. We'd sold this stock in August, shortly after the company's share price spiked on a buyout offer from Ireland-based Shire. For a while, this seemed like a timely sale, because Baxalta rebuffed Shire's initial offer. However, Shire revised its offer, and the two companies reached an agreement to join forces in January, which helped keep the stock in positive territory.

Conversely, our relative performance benefited from a non-benchmark stake in Denmark-based Genmab. After bottoming in February, the stock rebounded on a fourth-quarter earnings surprise due to success with Darzalex®, its recently-approved treatment for multiple myeloma. ■

LARGEST CONTRIBUTORS VS. BENCHMARK
Holding Market Segment Average Relative Weight Relative Contribution (basis points)*
Genmab A/S Biotechnology 2.64% 47
Medivation, Inc. Biotechnology 1.21% 18
Jazz Pharmaceuticals PLC Pharmaceuticals 1.74% 16
Actelion Ltd. Biotechnology 0.71% 14
Editas Medicine, Inc. Biotechnology 0.14% 12
* 1 basis point = 0.01%.
LARGEST DETRACTORS VS. BENCHMARK
Holding Market Segment Average Relative Weight Relative Contribution (basis points)*
AbbVie, Inc. Biotechnology -9.99% -135
Amgen, Inc. Biotechnology -12.85% -126
Gilead Sciences, Inc. Biotechnology -12.99% -108
Baxalta, Inc. Biotechnology -3.72% -56
Anacor Pharmaceuticals, Inc. Biotechnology 1.28% -52
* 1 basis point = 0.01%.

Outlook and Positioning

Despite the recent steep drop in biotechnology stocks, we believe the case for including them in a well-diversified portfolio remains compelling. From 2011 through 2015, the biotech sector enjoyed a historic advance, with the MSCI index outperforming the S&P 500® by a wide margin in each of those years. From the market low in 2002 through the end of 2015, gains from biotech industry benchmarks dwarfed the broader market.

Of course, past performance is no guarantee of future results. However, we believe this industry still offers exciting potential through discoveries that can treat and even prevent many diseases, while providing ways to lower the cost of health care through safer, less-invasive treatments. In turn, companies that participate in this process with commercially successful drugs have the opportunity to earn enviable profits.

That's the long-term picture. Over shorter periods, investors in biotech stocks must remember that they are a volatile group. Just recently we've seen how even a whiff of adverse political rhetoric can impact these stocks. However, volatility can be turned to our advantage, as downturns can be used to upgrade the fund's holdings. At the end of the first quarter of 2016, we continued to believe investors were undervaluing some of our favorite names, as these stocks were approaching double-digit free-cash-flow yields, with valuations reflecting minimal acknowledgement of their pipeline potential, in our view.

We also see the trend toward mergers and acquisitions in the group continuing for the remainder of 2016. The larger pharmaceuticals companies have a lot of cash on their balance sheets and are in need of the innovation and growth that biotechnology firms can provide. Additionally, we look for larger biotech firms to acquire their smaller peers. We believe the fund's approach of emphasizing smaller companies, alongside select positions in industry leaders, offers a prudent, yet potentially rewarding way to gain exposure to this dynamic market.

At the end of the quarter, the fund's largest individual overweighting was Denmark-based biotechnology stock Genmab, mentioned earlier as a contributor. We trimmed this position during the quarter but continued to like the stock.

Another significant overweighting at quarter end was Radius Health, a biopharmaceutical firm focused on developing therapeutics for patients with osteoporosis and other serious endocrine-related diseases. Although it was a detractor this period, we believed the company could benefit from the increasing need for effective injectable drugs to treat osteoporosis. 

In line with our philosophy of tilting the fund toward smaller companies, our biggest underweightings at the end of December were large-caps, including Amgen, Gilead Sciences, AbbVie – which we did not own – and Celgene. ■

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