Biotech. It's a simple, three-syllable word, but it's all it takes to get Rajiv Kaul pumped up.

Biotechnology not only saves lives. It can make for a lucrative investment, says Kaul, the portfolio manager of Fidelity Advisor Biotechnology Fund.

Indeed, Kaul likens the biotech industry to Silicon Valley in 1984 when a slew of startups and emerging technology companies kicked off 25 years of immense returns for investors (albeit with one very nasty crash).

The biotech industry, he says, is taking off in much the same way. "My long-term view is that the next five, 10, 15, 20 years for the [biotech] industry will be one of the most promising places to be in the world," he says.

Kaul's optimism stems from advances in diagnostics and genomics, which, he says, are allowing biotech companies to create more targeted medicines with better outcomes. "The quality of drugs in the pipeline should improve," and that, he says, makes him hopeful that the future for the industry will be robust.

The past few years certainly have been significant ones for the fund, which Kaul has managed since October 2005. It was the third best-performing fund over the 12-month period that ended on June 30, yielding 29.3%, according to Morningstar. It enjoyed three- and five-year annualized returns of 21.5% and 11.1%, respectively.

As fund companies are inclined to say, however, investment returns are far from guaranteed. And that's especially true in biotech, which is a risky business with two extremes: companies are either fabulously successful or they fail-fabulously. Companies that manage to find a "breakthrough drug" will enjoy advantages that make them virtually unbeatable in the market, Kaul says.

They'll have "one of the best business models in the world," with high barriers to entry, high margins and intellectual property protection for over a decade.

More often than not, however, new wonder drugs do not live up to expectations. Drugs that show great promise in the lab often don't survive clinical trials, with 80% to 90% of all new compounds failing, according to Kaul.

New medications often take years to get to market, and anything can go wrong as they wind their way through the rigorous regulatory approval process. "The process of discovery is a costly process ... and the cost of failure is very high," Kaul says.

Therefore, when investing, "one has to be conscious of minimizing the risk of blow-ups and disappointment in the labs," he says.

How does Kaul pick biotech's potential future winners? He engages in good old-fashioned "fundamental work," looking at company financials, such as cash flow and earnings growth. More important, he carefully evaluates the potential of each product, assigning each a probability of success.

To do that, he talks to opinion leaders, studies the competitive landscape and assesses pricing challenges, medical need and the global size of the opportunity.

Always, he says, he weighs "the downside risk if one is wrong" with "the returns on the upside if they [the drugs] work out as they should."

In this "fundamental-driven process," Kaul relies heavily on data from clinical trials. It trumps all the other information he collects in his analysis of biotech companies. "Being able to understand the data and being able to understand the value of the data," Kaul says, are critically important in assessing a company's potential.

Kaul favors companies that he thinks have a high probability of success. Very often, those happen to be companies overlooked by Wall Street, those that the Street "perceives to be damaged stories because they don't understand the value of the pipeline," he says.

For example, Kaul bet on Genentech soon after the company received approval in the late 1990s for Herceptin, a drug used to treat a certain type of breast cancer.

While Wall Street had written off the drug, Kaul's fundamental work showed that it could have significant effects on patients and had the potential of being a "mega blockbuster medication." He was right. The drug today has global sales of more than $5 billion and was one factor in making Genentech one of the best investments of the last decade, according to Kaul.

Indeed, in March 2009 Roche paid an eye-popping $46.8 billion for the remaining shares of Genentech that it didn't already own. And that was when the stock market hit a low point. "It was one of the biggest wins for our investors in the last couple of years," Kaul says.

As big as the wins can be, Kaul is cautious in managing downside risks. A small company's stock can fall 80% in one day if one of its drugs fails. To minimize that risk, a majority of the fund's $138 million in assets are invested in large-cap biotech companies, which generally have less risk than smaller ones, Kaul says.

While Kaul declined to discuss specifics about any of his investments, he said that they all have strong earnings and pipeline drugs that are very promising.

The fund's top pick, Gilead Sciences, a $39.3 billion company (market cap) based in Forest City, Calif., focuses on drugs for infectious diseases, including hepatitis, HIV and infections related to AIDS. It accounts for 10.5% of the fund's assets, according to Fidelity's monthly holdings report dated May 31.

Rounding out the fund's top five picks are Biogen Idec (6.9% of assets), Vertex Pharmaceuticals (5.9% of assets), Celgene (5.8% of assets) and Regeneron Pharmaceuticals (5.3% of assets), according to the Fidelity report. The fund invests heavily in U.S.-based companies. Almost all of its 153 companies (97.6%) are based in the United States.

The fund is invested almost entirely in equities, with 4.7% held in cash, according to the company's fund fact sheet. Its goal is capital appreciation.

Kaul also manages the much larger Fidelity Select Biotechnology Portfolio, which has $2.1 billion in assets. That fund ranked fourth on Morningstar's list, just behind the Fidelity Advisor Biotechnology Fund.

Kaul, a 1995 Harvard graduate, joined Fidelity as an associate analyst in 1996. He has spent the better part of his 16 years at the company focused on biotechnology stocks, and he says he hasn't regretted it.

There's much to love about the biotech industry, Kaul says. In addition to improving people's lives and increasing life expectancy, the industry attracts many Nobel Prize winners and some of the world's top scientists and researchers. Meeting them, he says, is one of the perks of the job.

Last but not least, the biotech industry might well be an answer to mounting health-care costs. "Biotech is one niche where innovation can actually improve outcomes and drive down health-care costs," Kaul says. "It's more cost effective to give a person a cholesterol-lowering drug that prevents cardiovascular complications versus people being treated in a critical-care setting."

For Kaul, it's a feel-good industry all around. "I'm optimistic that if you take a long-term approach as in three, five, 10 years," Kaul says, "this industry will continue to grow rapidly and should be a really profitable place for investors and also good for America and the world."

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