Live Oak Health Sciences Fund
By Lori Pizzani
November 4, 2003

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How’s your health these days? Exactly!

That’s the underlying premise behind the investment focus of the $21 million Live Oak Health Sciences Fund (LOGSX) managed by Oak Associates of Akron, Ohio. Demographics, including the future need of aging individuals to take more prescriptions to maintain health, is a big theme for this fund. Innovation and the technological advances that will translate into even better therapies down the road is also a key element of this all-cap sector fund’s philosophy.

But for all of its belief in cutting edge, don’t expect this fund’s managers to jump in and out of stocks as its prescription for success. This fund stays healthy by taking concentrated positions in a couple of dozen stocks, playing up themes they think will give the fund a shot in the arm, then holding those positions for three to five years.

The fund is co-managed by Mark Oelschlager, and Brandi K. Allen, a healthcare analyst with the firm. Both have managed the fund since its inception on June 29, 2001. In this issue, Fundemail’s managing editor Lori Pizzani interviews Brandi K. Allen.

For additional information on the Live Oak Health Sciences Fund please visit: http://www.oakfunds.com

Fundemail.com: What made Oak Associates originally choose to launch a health sciences fund?

Brandi Allen: We realized that there was an opportunity because of the aging population and the tremendous amount of innovation we are seeing. As people age, they tend to take more drugs. But innovation is also bringing us better drugs and better therapies. This is a true growth area, and not just a flash in the pan.

Fundemail: What type of companies do you look for?

Allen: We look for visionary companies. By that I mean that they must have high quality management teams with not only a vision, but execution as well. We also tend to play up trends and we will load up on several companies in one specific area; genomic tool companies for example. In our basket approach, we will invest in several promising companies, believing that not all will succeed but some will emerge as leaders.

We also want companies with low debt and accelerating earnings, which for biotech companies might mean a 20% growth rate but for pharmaceutical companies only 10%.

Fundemail: Why genomics?

Allen: The first wave of genomics was sequencing the human genome. The next wave lies in leveraging that sequencing of the human genome to take a more targeted approach to customize treatments. Now, the whole new world of proteomics -- the study of proteins -- is becoming the next wave. There are millions of proteins, many, many more proteins than genes. And scientists are studying what effects proteins have on genes and other proteins; how they interact. All of this research will eventually lead to designer drugs which will be beneficial to the population.

Fundemail: Would you give us an example of a genomics company that you like?

Allen: We own Affymetrix (AFFX: Nasdaq) which is a gene chip company. It makes chips used for genetic research. A gene chip is used by researchers to take samples of sections of genes. They can then study how a particular gene expresses itself in an individual. Affymetrix has partnered with a major drug company, and they are working in the diagnostics area. That could be exciting with the potential for downstream personalized medicines.

We also own Applera Corp (ABI: Nasdaq), Waters Corp. (WAT: NYSE), Molecular Devices Corp. (MDCC: Nasdaq), Bruker Biosciences Corp. (BRKR: Nasdaq), and Caliper Technologies (CALP: Nasdaq). We consider these “tools” companies, and they make up the largest portion of the fund now at about 39%.

Fundemail: What other subsectors are you most heavily invested in?

Allen: The next largest sub sector is drug distributors and pharmaceutical benefit managers, which include Cardinal Health (CAH: NYSE), AmerisourceBergen (ABC: NYSE), and Express Scripts (ESRX: Nasdaq). These are all involved in the distribution of drugs.

There is great potential for the near term as the Medicare drug benefits bill winds its way through Congress. If approved, the volume of drugs would increase. These companies receive higher margins on generic drugs. If this bill passes, generic drugs will gain more prominence.

Our next largest subsectors are pharmaceuticals and biotech, respectively. In the pharma area we actually own only two companies now: Pfizer (PFE: NYSE) and Eli Lilly (LLY: NYSE). Pfizer has the scale and muscle, and is the partner of choice for many of the smaller pharmaceutical companies, and Eli Lilly has the strongest pipeline.

In the biotech sector, we own Amgen (AMGN: Nasdaq) and Genentech (DNA: NYSE). We started this fund with zero biotech companies because at that time they were overvalued. But we added both of these companies in 2002, and just recently added Medimmune (MEDI: Nasdaq). Medimmune is very well managed and has a strong product line. They are working on a new, follow-on drug to help premature babies with respiratory diseases. There is also a strong potential for their new FluMist flu vaccine which may present some short-term challenges for the company, but that is not an issue for our three- to five-year time horizon.

Fundemail: Is that three- to five-year time focus across the board?

Allen: Yes. We tend to be patient if we thinks things are going well, and we tend to let our winners run. Affymetrix has grown to a 10% position. That is the largest any of our fund holdings has grown. Our portfolio turnover rate is only 31%.

Fundemail: What about your sell discipline?

Allen: We will sell if performance of a company is not up to what we had hoped for. As an example, we sold out of Luminex (LMNX: Nasdaq) over a year ago. We had high hopes but they started stuffing products into their channels and their margins fell. We are quick to own up to mistakes. That’s one of the benefits of having co-managers.

We might also sell a position if we feel there is a better opportunity somewhere else.

Fundemail: What other interesting subsector is on your radar screen now?

Allen: We are looking at some of the specialty pharmaceutical companies, but they are pricey right now. These companies tend to be smaller and more focused than the big cap pharma companies and target smaller disease classes. Larger companies need to find the next big blockbuster drug to do well.

We do own specialty firms Medicis (MRX: NYSE) a dermatological company, and Teva Pharmaceutical Industries (TEVA: Nasdaq) an Israeli drug company.

For Medicis, their big breakthrough may be Restylane, which would be a competitor to Botox. It’s waiting FDA approval but has already been approved for use in Europe. It is being touted as lasting longer thereby requiring fewer injections. Teva makes one branded drug for multiple sclerosis, and is a leader in the manufacturing of generic drugs.

Fundemail: The fund had a rough year last year, losing 32.4%, but the fund is up so far this year 16.8% through September 30. What has changed?

Allen: Last year there was a struggling economy, and people’s concerns about spending helped drag down the healthcare sector with the rest of the market. There was a political overhang, and the struggling economy contributed to market difficulties last year.

In addition, our heavy bet into the tools sector helped us underperform. These companies depend on research and development (R&D) spending by drug companies.

This year, some of our companies are up triple digits. Genentech is up 147% through last night (10/31/03) and Invitrogen (IVGN: Nasdaq) is up 102%. Genentech was boosted by news this past May that the phase III study of its cancer drug Avastin did well. Invitrogen, a consumable company which sells life science tools used in genetics and molecular laboratories, is a turnaround story. A new CEO came on board six months ago, has been very vocal about cost cutting measures, and has already made four acquisitions this year.

Fundemail: What does the fund’s research process look like?

Allen: We attend trade shows and conferences and do on site visits. Also, because we are buy and hold investors, and the companies know that, they usually take our calls.

Fundemail: What do you see as the biggest challenges to healthcare sector as a whole over the next six to nine months?

Allen: The potential passage of the Medicare drug bill could be a negative and put more pressure on big pharmaceutical companies as the push to generic drugs builds.

The industry may also face the reimportation bill which would allow the U.S. to bring in cheaper drugs from Canada. If U.S. drug companies can’t charge a premium price, they may not be able to pump money into R&D, or they may need to fill more R&D jobs with cheaper labor offshore.

As a whole, healthcare tends to be less cyclical, relatively recession proof, and more defensive. But in good times, investors tend to sell out of the sector and go into technology so the sector can drop. The benefit here is that lots of these healthcare companies are also high tech companies in their own right. It’s a good play on technology.

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