(FORTUNE Magazine) – For almost two years, investors have quarantined pharmaceuticals and biotechnology stocks. From a peak in early 1992, both groups are down over 30%. The Medical Research Investment Fund has thrived nonetheless, returning 17% so far in 1993 and 25% annually over the past three years -- putting it first among its peers in Morningstar's rankings. Managed by Samuel D. Isaly of Mehta & Isaly in New York City, the $10 million fund invests in health care companies worldwide. Isaly, 48, who trained as an economist at Princeton and the London School of Economics, tells Fortune's John Wyatt where the buys are in a sector he thinks may soon recover.

Describe your investing approach. Today roughly 60% of our assets are invested in health care companies abroad. We look for the best value in health care, wherever that may be. We are about 40% in large-capitalization companies like the big pharmaceuticals and 60% in smaller-cap specialty pharmaceuticals and biotech companies. Our holdings range from Johnson & Johnson to Ares-Serono Group in Switzerland, the world's leading marketer of fertility-enhancing drugs.

Has your investment outside the U.S. risen under Clinton? Somewhat, but we also increased it in anticipation of his arrival. We are faced with changes in the U.S. health care system that have caused investors to be fearful about the rate of return in this sector. If the highest return is not available here, we will scurry elsewhere, and we have.

What are you finding? Considering risk and return, our favorite stock is Schering AG, Germany's only purely pharmaceutical company. It has a major new product, Betaseron, the ^ first and only treatment for multiple sclerosis. Schering has been focusing on its core business, selling off industrial and agricultural chemicals. It has about $1.5 billion in the bank. The share price is about 1,098 deutsche marks (($650)). Earnings are going to grow 20% to 25% annually, potentially through the end of the decade. We wouldn't be surprised to see the shares around 1,500 marks (($888)) in the next three to six months. There's no American depositary receipt, but any major brokerage house can buy the stock for you on the Frankfurt exchange.

What about the big U.S. pharmaceuticals? We like Pfizer for many of the same reasons. It too is focusing on its core business, and it has a lot of new products -- Zithromax, a good antibiotic; Norvasc, for high blood pressure; and Zoloft, an antidepressant similar to Eli Lilly's Prozac. All are potentially $1-billion-a-year products. We see earnings growing 12% to 15% annually for the next three to five years. The stock should move in line with that, if not faster.

Have the biotech companies bottomed out? They seem to have, although these things are always uncertain. I think there is substantial upside to biotech. The total market value of all biotech stocks is about the same as that of Merck. A rather minor shift in investor psychology can mean a relatively major flow of funds.

Some biotech companies you like? Immunex is a very special situation. It has a good operating business in anticancer agents, and on top of that it is a leading biotechnology discovery force. It is developing a drug called PIXY-321, an immune-system booster used mostly in conjunction with cancer therapy. That won't appear until about 1996. Estimating earnings growth in this case is not particularly meaningful. If PIXY is successful, earnings could grow 100% a year. If not, they will grow 10% or less. Another cutting-edge technology company is Vertex Pharmaceuticals. Vertex is dreams. It is based on what is sometimes called rational drug design, which uses the newest techniques of X-ray crystallography to make models of various molecules that occur in the body. Then you genetically engineer drugs to counteract or enhance them. Vertex is working on the next generation of AIDS therapy. If it succeeds, that will translate into a very large gain in the stock price.

Any final recommendations? Takeda Chemical Industries is a neat company. It's over 200 years old, and it's Japan's largest pharmaceuticals company. Takeda has a joint venture with Abbott Laboratories that sells Lupron, used to treat prostate cancer and endometriosis, a thickening of the uterus. In addition, Takeda is rolling out a new state-of-the-art ulcer drug, Takepron. Again no ADRs, but a major brokerage can buy it for you. Another value is Allergan, one of the two world leaders in ophthalmological pharmaceuticals. If you've got any problems with your eyes -- viruses, inflammations, infections, glaucoma -- these guys have a drop for it. We expect earnings to rise 10% to 15% a year as far ahead as we can see. The stock should climb accordingly.

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