Lessons From A Losing Biotech Portfolio

BOSTON (TheStreet) -- Changes made in August to the Biotech Stock Mailbag Readers' Portfolio (BSMRP) provided a modest boost to performance but the portfolio's overall return is still deep in the red and has little hope of outperforming its biotech sector benchmark for the year.

I'm afraid it's time to pull the plug on this failed experiment in reader-generated biotech stock picking, but still, there are good biotech investing lessons to be learned from the losses.

As of November 23, the BSMRP, a portfolio of 20 biotech and drug stocks chosen by readers of my weekly Biotech Stock Mailbag, is down 13% compared to a 6% gain in the benchmark iShares Nasdaq Biotechnology ETF. If this were a real biotech hedge fund, investors would be asking for redemptions and the portfolio manager would be looking for a new job.

Instead of dwelling on the negatives, let's look at the reader stock picks that performed well. The No. 1 pick was Keryx Pharmaceuticals(KERX), which returned an impressive 89% this year. Keryx was an original pick in the BSMRP, added Jan. 15 at $2.77. The stock closed Friday at $5.18.

No. 2 among the stocks picked by readers in January was Ariad Pharmaceuticals(ARIA), returning 58%.

What's interesting about Keryx and Ariad is that both companies have late-stage drugs in incomplete phase III studies, yet neither company has a drug approved nor generates any product revenue. In that respect, both companies are works in progress that have yet to live up to their potential -- and may or may not depending on the outcome of their ongoing phase III studies.

That both Keryx and Ariad delivered the top returns in the BSMRP shows how biotech investors often prefer to take early, anticipatory positions in biotech stocks ahead of major stock-moving events like phase III study results or FDA approval decisions. This is the "Bio Run-Up" strategy that's become a popular biotech stock trading method this year.

The announcement of results from the respective phase III studies underway by Keryx and Ariad are expected next year. Adherence to the rules of the "Bio Run-Up" trading strategy requires selling positions ahead of the stock-moving catalyst. It will be interesting to watch if this rule applies to both these stocks as the respective data releases near.