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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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Select Biotechnology Portfolio: Quarterly Fund Review
DECEMBER 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 and industry 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 December 31, 2015, the biotechnology industry, as measured by the MSCI U.S. IMI Biotechnology 25/50 Index, considerably outdistanced the broadly based S&P 500® index.

Biotech stocks rallied sharply with the broader market in October, followed by choppy action the following two months. However, biotechs were somewhat stronger near the end of both October and December, enabling them to finish ahead of the S&P 500®. The group attracted some additional buying after selling off sharply toward the end of September, following comments about drug company "price gouging" from one of the U.S. presidential hopefuls.

October's broad-market advance was driven by easing fears about China and crude oil, two factors that had contributed to earlier weakness. November and December were volatile, as investors came to terms with the growing likelihood that the U.S. Federal Reserve would raise short-term interest rates for the first time since 2006, a move the central bank made in mid-December. That same month, the Organization of the Petroleum Exporting Countries (OPEC) could not agree on a production ceiling that would reduce the glut of crude oil sending oil prices down further and unsettling the broader stock market.

Often less influenced by macroeconomic factors, biotech stocks proved resilient, benefiting from an uptick in merger-and-acquisition activity and a wave of positive news on drug development and innovation. In 2015, the U.S. Food and Drug Administration approved 45 "novel new drugs," the most in nearly two decades.

The quarter's volatility helped propel stocks of larger-cap names with seemingly healthier balance sheets. Strong performers in the MSCI index included major constituents Alexion Pharmaceuticals (22%), Vertex Pharmaceuticals (21%), Amgen (18%) and Regeneron Pharmaceuticals (17%). ■

Performance Review

For the quarter, the fund posted a low-double-digit gain, outperforming its benchmark, the MSCI U.S. IMI Biotechnology 25/50 Index. Stock selection in the small- and mid-cap groups aided the fund's relative performance. As a reminder, we believe smaller companies typically offer the best opportunities for identifying undiscovered value through the kind of comprehensive research we bring to bear here at Fidelity.

The fund's largest relative contributor was our sizable underweighting in Gilead Sciences, a major component of the index, and as such, one of the fund's largest holdings. This stock has been unable to maintain its prior impressive rate of appreciation, as investors worried that the company's two blockbuster hepatitis C drugs, Sovaldi® and Harvoni®, might be near their commercial apex because of competing medicines and continued resistance from payers, among other factors. Gilead returned approximately 4% for the quarter, underperforming the double-digit return of the MSCI benchmark.

Overweighting Ophthotech also paid off, as the stock nearly doubled in price for the quarter. In October, investors cheered positive developments surrounding clinical trials for Fovista®, its treatment for a type of age-related macular degeneration, a disease of the eye. November brought more good news on Fovista: Roche Holding subsidiary Genentech said it would opt-in to share rights for the drug's commercialization outside the U.S. with Novartis. We maintained our overweighting given Ophthotech's experienced management team and our belief that the company's product pipeline was undervalued.

Conversely, underweighting index heavyweight Amgen, the fund's largest relative detractor, worked against us, given the stock's solid return. An overweighting in Zafgen also detracted. The stock fell sharply in October and returned roughly -80% for the quarter. In mid-October, the company disclosed that clinical trials of beloranib, its obesity therapy designed to reduce hunger, were placed on hold following the death of a participating patient. ■

LARGEST CONTRIBUTORS VS. BENCHMARK
Holding Market Segment Average Relative Weight Relative Contribution (basis points)*
Gilead Sciences, Inc. Biotechnology -10.22% 76
Ophthotech Corp. Biotechnology 0.96% 63
Dyax Corp. Biotechnology 0.29% 60
Genmab A/S Biotechnology 1.92% 59
Acceleron Pharma, Inc. Biotechnology 0.54% 36
* 1 basis point = 0.01%.
LARGEST DETRACTORS VS. BENCHMARK
Holding Market Segment Average Relative Weight Relative Contribution (basis points)*
Amgen, Inc. Biotechnology -11.14% -73
Zafgen, Inc. Biotechnology 0.19% -44
Radius Health, Inc. Biotechnology 1.49% -39
GW Pharmaceuticals PLC ADR Pharmaceuticals 0.76% -32
Baxalta, Inc. Biotechnology -2.49% -32
* 1 basis point = 0.01%.

Outlook and Positioning

We remain big believers in biotechnology stocks as a valuable component of a well-diversified portfolio. This industry has the potential to offer 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, and we as investors can try to ride their coattails.

That's the long-term picture. Over shorter periods, investors in biotech stocks must remember that they are a volatile group. However, volatility can be turned to our advantage, as downturns can be used to upgrade the fund's holdings. At the end of 2015, 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.

It was also a peak year for mergers and acquisitions in the group, a trend we see continuing in 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 largest individual overweighting was Denmark-based biotechnology stock Genmab, which contributed to the fund's results for the period. This stock has climbed our list of overweighted holdings due to its strong showing, as it returned 46% the past three months. In November, the company received early U.S. approval for Darzalex®, a new drug for treating bone marrow cancer. The drug, which Genmab licensed in exchange for royalty payments, is expected to result in more-predictable profit, and may help fund other drug candidates.

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. We like this stock, believing 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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