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I've been reading that biotechnology is the investment wave of the future. What are the risks and rewards of this sector?

Biotechnology - a powerful blend of medical science and cutting-edge technology - has been a hot area within the health sciences in the past two years. A combination of government funding and a new surge in investment dollars has rejuvenated this cyclical sector.

Groundbreaking discoveries in medical laboratories, tax advantages, and an ageing population keen on drug advancements, have all played a part in renewed interest in the biotech area. Biotech fund investments fall under the rather awkward description of labour-sponsored venture capital funds. The shortened description - labour funds or venture capital - is often used for the sake of simplicity.

Snapshot of a Biotech Investment

Canadian Medical Discoveries Fund Inc. is a good example of the challenges of a biotech fund. Dr. Calvin Stiller, who co-manages the fund with MDS Capital Corp. in Toronto, thinks the biotechnology frontier will be, "as transformational as the Internet," but also adds, "it takes five to eight years of every single investment to be tested, and the average investment right now is only 34 months old." This particular fund, while earning a fourth ranking among 24 labour-sponsored funds in Canada, characteristically experienced both a slow start and volatility in performance returns since its inception in 1995.

Characteristics of Biotechs

Because biotechnology investments usually concentrate on smaller, early-stage companies, they are inherently more risky, with little track record. As with most labour-sponsored investments, the biotech companies targeted for funds have less than $50 million in assets and fewer than 500 employees. Biotech investments don't tend to follow the stock market curve. The success of fledgling companies is more influential - and also more volatile - compared to other investments.

Advantages

Tax Sweeteners   The RRSP season fuels a renewed interest in biotechnology labour-sponsored investments. Investors receive a combined federal and provincial tax sweetener of 30 per cent.

Foreign Content Boost   By holding a biotech labour-sponsored investment inside your RRSP, you can boost your foreign content limit up to a maximum of 50% (in 2001). For example, if you invest $5,000 of your RRSP money in a biotech labour-sponsored fund (or any labour-sponsored fund for that matter), you can hold an additional $15,000 in a foreign investment, as long as the total of your foreign book value does not exceed 50% of your RRSP's book value.

Potential Returns   As with many early-development investments, the long-term gains can be great. But we need look no further than hot-tech investments to realize that high potential returns also come with high risk.

Cautions

The biotech sector will test your investment mettle. If you are not a long-term investor - meaning over 8 years - and can't sleep at night during investment swings, this volatile, often speculative sector is not for you. If you cash out before the minimum investment period of eight years, you will incur expensive taxes and probably redemption fees as well. They're expensive. Biotech funds are actively managed funds and, because the underlying companies are so research-intensive, they tend to be more expensive that other funds. Should Canada experience a recession of some duration, the impact could be significant on small and medium-sized companies.

Safeguards when investing in biotechs

It is difficult to pick a lone-star success story. Biotech mutual funds offer diversification and professional management. By limiting your portfolio to 5 to10% in biotech holdings, you'll reduce your risk. Purchasing a biotech fund through monthly or quarterly dollar-cost averaging, reduces volatility. Biotech experts say a company's, or fund's success, is based on the experience and expertise of its management. Check out the history and business experience of the managers and directors through the prospectus or through a professional adviser. Check out the cash position of a biotech company or fund. A large cash position is needed in the early stages to fund ongoing research and to offer cash in the case of mutual fund redemptions. Don't purchase the investment solely for tax purposes. If you are not in for the long haul, the tax advantage will end up being a tax disadvantage. Be comfortable with your investment.

Bookmark

One of the best web sites for detailed prospectus information is www.sedar.com Because biotech companies and funds have a shorter track record, this information is invaluable.