Q:  What is unique about healthcare sector? A: There are very few sectors that occupy such an important intersection between business, public policy and societal aspirations. When you start highlighting people’s priorities, people for the most part desire to be healthy and have a high quality of life. The products of the healthcare industry are of incredible importance when you lose your health. In most industries you have some level of demand and the industry springs up to generate supply but in healthcare more supply creates more demand. For example, right now we don’t have a market that has a high demand for Alzheimer’s disease because we don’t have great therapies. But if we were to have great therapies, all of a sudden the demand would explode and that is the unusual characteristic of the therapeutic-based area of the healthcare market. The aging demographic brings with it a higher consumption of healthcare and the United States has a world-class biomedical infrastructure that is a national treasure and competitive advantage. That biomedical infrastructure is the basis for which better therapies are developed. Q:  What are the main categories within the healthcare sector? A:Within healthcare, the world is broken down into four broad categories. The first is pharmaceuticals, both domestic and international, also including subsets such as specialty pharmaceuticals and generics. The second is healthcare services. Examples here would be managed care, hospitals, dialysis companies or any company that is not making a therapeutic, but is involved in the delivery or the administration of healthcare to a patient. The third area is medical devices or Med Tech companies. These tend to be orthopedic companies that make devices used as a therapeutic, to replace a knee or a coronary stent or a catheter. The final area is biotechnology, which is a category of companies whose products were protein-based as opposed to chemically synthesized orally available pills that we take. These categories have lost their distinctions over time because many of these companies have evolved so that their products are improved through a common mechanism. They often compete with one another. Their business models are similar, but they still retain these categorical distinctions for the basis of Wall Street classification. Q:  Are you overweight in some of these healthcare areas? A: About 75% to 80% of the fund’s long-term investments are in therapeuticbased companies or companies that make medicines, vaccines, and any therapy that tries to cure a patient of a disease or tries to prevent a disease. The other 20% is invested in healthcare services or companies that provide medical insurance or are involved in the distribution of pharmaceuticals. Q:  Why do you put a greater emphasis on therapeutic-based companies? A: If you look at what companies today are the most valuable at the top of the list you would find Pfizer, Johnson & Johnson, Amgen, Genentech, Novartis, Roche and what most of them have in common is that they are in the business of providing therapeutics to patients. Q:  What is your investment philosophy? A: Healthcare is a very special place in our society because on the one hand, it is a business and on the other hand, it affects health that is very precious to all of us. There is an escalating tension between the ability to pay for healthcare and the desire to have more healthcare. One of the things that shapes our long-term philosophy is that we are always mindful of the fact that this tension is not going away; in fact, it is only going to escalate. Q:  What kind of companies are you looking for? A: We don’t want to just be involved with any company that provides a therapy, but with companies that provide therapies that make a significant impact on a patient’s disease. We are looking for companies whose medicines are differentiated from the other medicines. One of our long-term philosophies is that society will continue to reward companies providing therapeutic solutions for heart disease, high blood pressure, diabetes, HIV disease, Alzheimer’s disease, just a wide-range of common ailments. Society will continue to award those companies that bring to the marketplace a medicine that is highly impactful and has the potential to become a standard of care type medicine. The tension between the desire to obtain more healthcare and the ability to pay for it continues to escalate and it will not go away and therefore the rewards will be increasingly reserved for those medicines or therapies that are really impactful. Q:  Are these types of new medicines in small, medium or large sized companies? A: They can come from any kind of size of company but if we can find them in the context of a smaller company, we have the opportunity to leverage our shareholders to a company whose future is about to be transformed in a dramatic way by virtue of the introduction of an important new medicine, all else being equal. For example, we have a long-standing investment in Gilead Sciences. Gilead has the best in class medicines for the treatment of HIV AIDS, and its market cap, over the nine years that we have been involved with the company, has gone from about $750 million or $1 billion, all the way up to $26 billion today. That is a dramatic return and it speaks of the value Gilead’s medicines have for a very serious illness. Relative to our peer group, our median market cap is smaller because we tend to have a greater number of holdings whose market caps are below $10 billion, as opposed to above $10 billion. Q:  But with the smaller companies in most cases this may be their only medicine. A: That is correct. One-product companies are at much greater risk of something unpredictably bad happening to them, than a company that has ten or twelve products and if you lost one, it is not that devastating. So, that is why I say all else being equal. Q:  How many analysts work for you to help you identify these companies? A: We have six full-time healthcare analysts whose job it is to cover the sectors and we generate healthcare ideas not only for the T Rowe Price Health Sciences Fund, but for the firm overall. We have a pharmaceutical analyst in London who has the non-U.S. pharmaceutical companies, as well as Japan and some healthcare companies in Europe. I myself also function as an analyst and we have four other full-time healthcare analysts. Q:  How is your research process organized? A:We have an internal rating system. We have daily written research commentary. We spend the majority of our time visiting companies on site; they visit us; we speak frequently to management; we go to every significant major medical meetings for diabetes, cardiovascular disease, infectious disease, cancer to obtain a good understanding of a lot of drugs that are still in their experimental, development phase. Our best ideas generally relate to companies with unrecognized value. Unrecognized value can come from a growth rate that is about to accelerate or something that is totally unrecognized in the pipeline. That component of unrecognized value could be where our perspective on the company’s growth is greater and more sustainable, than is currently embedded in its share price. We are not held to any particular investment style. We have companies that one might call value stocks and companies that have high multiples and growth rates but the common denominator is a belief that we are holding a core position that has underappreciated value in the marketplace and we can deliver to our shareholders below average risk. Q:  How do you control risk? A: We use three ways to control risk. One is referencing position size or the percentage that a security comprises in your portfolio. The second way to control risk is based on the price of a stock. The third way has to do with the use of options. Q:  Can you describe your buy and sell disciplines? A: In general we will sell a stock outright if it is clear that our investment thesis turns out to be wrong. We won’t try to re-weave a story and we won’t wait longer to see if something else might materialize. Alternatively, we both add to a position and trim a position that remains a core position, which means that the investment thesis is intact but the company’s share price is fluctuating at a considerable range. In that regard, we might modestly trim a core position by 10% or 15% or add to it based on the inherit volatility that affects many of the holdings in the portfolio. Q:  Do you consider yourself a value investor or a growth investor? A: Looking at the majority of our holdings, most people would describe us as growth investors. I believe that the healthcare sector as a whole is a growth sector. Within our sector we are looking for growth that we don’t have to overpay for, or we are looking for a return to growth that may be underappreciated. So it’s both value and growth at a reasonable price. Imagine a graph and on the “x” axis is time and on the “y” axis is value or money. You start a straight line from the origin and have it at a 30-degree angle off of the “x” axis - that is the growth profile in earnings per share of a growth company. You keep that line and put one more line that only goes about five or ten degrees off of the “x” axis – that is what you might call a “value stock,” slow growth, inexpensive, etc. The reward for a value investor is to identify the companies that are slow growing but whose growth rate is going to improve and that second line is going to move up. The risk to the value investor is if that growth rate simply maintains itself and never moves up. The inverse of that is the growth situation. The reward for a growth investor is if a company can maintain a high or above average growth rate for some sustainable period of time, hopefully measured, at least in terms of a few years. The reward for the investor is to have an investment in that company while the slope of the growth line did not change over a period of time because stocks absolutely track their level of earnings over time. The risk to the growth investor is when the company’s growth rate materially changes where for a value investor their reward is where a value-based stock’s growth rate actually changes in a positive way. As you think through that graph and those two lines, one being the line describing the growth of a value stock, the other being a line describing the situation of a growth stock, we are interested in those two lines as well as the line in the middle of those two, which is growth at a reasonable price. Q:  What is the number of holdings in your fund? A: Our number of holdings has drifted up over time. We have 150 - 155 holdings right now. Our portfolio has what I would call ‘a long tail’ and by that I mean we have several positions of small size and it goes back to the ways to control risk as the new emerging therapeutics are often found in very small and highly risky companies. Q:  Do you believe in concentrated bets? A: Absolutely. If you are in a sector fund, you are already concentrated by nature. I don’t want you to think that all our 150 or 160 positions are of equal size. We have 30 or so small investments in companies that represent higher than usual risk. Our top 25 positions represent 49% of the fund.