It's hard to find a more experienced biotech investor than Evan McCulloch. The manager of Franklin Biotechnology Discovery has been running the $1.2 billion fund since 1997.
That matters in this highly specialized healthcare sector, which can be extremely volatile-yet rewarding to investors who play it right. Biotech tends to have big boom-and-bust cycles. Right now we're in a boom. The $10.8 billion State Street SPDR S&P Biotech exchange-traded fund has surged 77% in the past 12 months, but has returned only 5.3% annualized in the past five years because of the previous bust.
By contrast, Franklin Biotechnology Discovery has lagged behind in the short term, up 72% in the past year, but has a much higher 13% five-year annualized return. That's because McCulloch and his co-manager Akiva Felt know how to be defensive during downturns in the sector's investment cycle. "I've seen at least three cycles across the sector, and these long, extended bull runs usually start with low valuations and some sort of catalyst, usually M&A activity," McCulloch says. "They usually end with some sort of legislative threat."
The current rally began during the depths of the tariff-related downturn in April 2025, as low valuations sparked a wave of acquisitions. "Right now, I would say we're in the fifth or sixth inning of the current bull market," McCulloch says. "Valuations have certainly moved up off the bottom. We find them to be about in the middle of the historical range, but also we expect this [acquisition] wave to continue."
Acquirers tend to focus on more volatile, smaller biotech companies. McCulloch's flexibility enables him to play either offense or defense. When he's bullish, he'll load up on small-caps; when bearish, larger, more stable companies. Right now the fund is composed of about 50% small-caps, which McCulloch defines as companies with market capitalizations below $2 billion. The fund's allocation ranges between 33% and 55% small-caps, he says, so he's still playing offense.
In small-caps, McCulloch will sometimes participate in initial public offerings of companies that aren't found in most index funds. One recent example is Parabilis Medicines, which went public this June with a market capitalization of $670 million. Its lead drug candidate, Zolucatetide, targets difficult-to-treat cancers and is about to enter Phase 3 of clinical trials. Zolucatetide inhibits the beta-catenin and T-cell factor interaction, a chain reaction that drives cancer growth previously thought to be untreatable with drugs. "It will ultimately take the leading position in what we view as a $4 billion" total addressable market, McCulloch says.
Zolucatetide has also proven highly effective at treating familial adenomatous polyposis, "a rare genetic disease where patients develop hundreds of precancerous polyps all throughout the colon," McCulloch says. "It's not possible to remove them all. Unfortunately, many of these patients end up having to have their colon removed."
McCulloch's analysis of the company's pre-IPO drug efficacy reveals the difference active managers can make in this highly technical sector. It goes beyond simply studying income statements. "I've looked at many companies in the gastroenterology space, and you cannot mistake the improvement in these colonoscopies" after patients used Zolucatetide, says the manager, who examined colonoscopy photos. "They went from colons I've not seen anything like before to as smooth as you would want to see in a healthy 20-year-old. So, I was very encouraged."
Yet part of McCulloch's risk control is to not take too large a position in newer companies. Biotech tends to be a sector with binary outcomes, with companies getting a huge pop when their drugs receive regulatory approval or collapsing if their drugs don't. With small companies whose drugs are still in clinical trials, his average position size is only 0.66% of the fund's portfolio, and Parabilis was initially about 0.30%. Only "one in 15 drugs that enter clinical trials are approved," he notes.
Gradually, with each advancement in clinical trials and regulatory approval, a biotech stock will grow in size in the portfolio from appreciation, and McCulloch may add to his position. "A biotech stock is a summation of the probability-weighted cash flow streams" of its drugs, he says. "It's super simple to think about it as a single-product company with a single [drug] indication. If you flip over the Phase 2 [clinical trial] data card and it's positive, your overall probability of success goes from 33% to 66%, and then it goes to 90% after Phase 3."
The fund's largest positions typically aren't bigger than 5%. That's a stark difference from broader healthcare index funds like the $44 billion State Street healthcare Select Sector SPDR ETF, which has 15% in Eli Lilly and 10% in Johnson & Johnson. "Our largest positions are household names-Amgen, Gilead Sciences, Regeneron Pharmaceuticals, Vertex Pharmaceuticals," McCulloch says. Jazz Pharmaceuticals is currently the largest at 5.7%, but only because the stock has soared 111% in the past year. The average large-cap biotech stock is 2% in his currently 102-stock portfolio.
"These are multiple-product companies with large drug pipelines," he says. "That's the part of the portfolio that stabilizes the fund in periods of volatility. That's not the part that drives outperformance in an up market."
More valuable as a differentiator in a biotech boom are companies like Oruka Therapeutics. McCulloch added it to the fund in September 2024, when the company was worth only $500 million. It was developing a plaque psoriasis drug called ORKA-001. "They had no clinical data," McCulloch says. "It was in Phase 1, but the market cap was really low. ORKA-001 is basically AbbVie's Skyrizi [psoriasis drug] with a mutation that allows for a significantly extended half life." Oruka is now worth $7.5 billion.
The fact that the drug was similar to Skyrizi, but patients could use it less frequently, gave him confidence to invest 0.5% of the fund in it. This April's Phase 2 clinical trial results revealed better skin clearance with ORKA-001, bolstering that confidence. The stock has surged 633% in the past year, and is now 2.5% of his portfolio. But McCulloch might not have risked investing in it if he hadn't bought a small position first.
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