Amid the doldrums of venture capital, the folks at MPM Capital are on a tear.

Late last year, as venture capital firms left and right were returning money to investors because they could find no place to put it, MPM Capital dropped a bomb on Silicon Valley: The firm, focused solely on health care investing, raked in $900 million, the largest venture fund raised all year, and the largest health fund ever. Eyebrows went up over how, in this risk-averse climate, a firm could reach $2.1 billion under management in only six years. “It used to take a decade to raise $2 billion,” says Jean-Franois Formela, partner at Atlas Venture.

Now all eyes are on MPM (stands for Medical Portfolio Management) and what it decides to do with so much money. In the 1990s the kings of venture earned their fortunes from big bets on broadband and the Web. Now it’s biotech’s turn. In the first nine months of this year $3.4 billion in venture money poured into health care companies in the U.S., accounting for 28% of all venture funds invested, according to VentureOne, up from 10% in 2000.

Drug development has been absorbing speculative capital since Genentech went public in 1980. The next decade or two–finally, finally–will see abundant fruit from sequencing the human genome. But big pharmaceutical companies are so wrapped up in finding blockbuster drugs that they’re leaving lucrative gaps for smaller biotechs to fill. Says MPM founding partner Ansbert Gadicke: “We understand mechanisms in disease after disease.”

The partners at MPM are at the top of the game because they’ve been at it for so long. “Most firms will sort of play market timing if biotech is hot and [information technology] is cold. MPM is consistent. Whether it looks hot or looks cold, they’ve been investing,” says David Baltimore, a Nobel laureate and the president of the California Institute of Technology, who chairs MPM’s medical and scientific advisory board (and who vetted every investment in MPM’s first fund). In that fund, a $230 million chunk raised six years ago, MPM has exited just under half its investments with an 91%unaudited internal rate of return.

The firm plans to invest in three main areas: cancer, metabolic diseases like diabetes and obesity, and diseases of the central nervous system such as Alzheimer’s, depression and schizophrenia. Oncology is attractive not only because of the huge need for better drugs, but also because that’s where the impact of the human genome project has been greatest, yielding targeted drugs such as Genentech’s Herceptin for breast cancer and Novartis’ Gleevec for chronic myeloid leukemia.

MPM has, arguably, the most scientifically astute and well- connected group of partners and advisers at any venture firm. Its payroll includes the former chiefs of research at Genentech, Roche and Merck. Gadicke, 45, is both a physician and a scientist who did research at MIT’s Whitehead Institute.

Edward Scolnick joined MPM’s advisory board 2 years ago, after 16 years running Merck’s research labs, a stretch in which he never had a drug turned down by the Food & Drug Administration. Says Scolnick: “They have a similar approach to what we had in the Merck labs: We were critical scientifically of our own data, and we used to really argue about what to do.”

MPM taps its network for investment ideas. Dennis Henner joined MPM as a partner in 2001, after 20 years at Genentech, where he served as head of re-search. Henner knew about a growth hormone discovered at Genentech but not fully developed into a drug. It took 16 months, but Henner and others at MPM convinced Genentech to license the rights to the hormone to a new company, Tercica, funded with $12.5 million in May 2002 by MPM. (Genentech owns a stake.) Tercica hopes to raise $75 million in a late-November public offering.

MPM thinks big. Developing a new drug takes years and costs at least $100 million. MPM’s average deal these days is $22 million. “You need to deploy significant capital so you can add value and reach milestones and convince the public market that you are close to having a drug,” says Gadicke.

In 1997 Gadicke was introduced to Jean Pierre Sommadossi, a brilliant French scientist who had some novel antiviral compounds but no business plan. Over three years, beginning in 1998, MPM invested a total of $18 million, and helped turn the science into a privately held company called Idenix Pharmaceuticals. Idenix is developing drugs for Hepatitis B and C, diseases that affect 520 million people. In March Novartis announced it would buy 51% of Idenix for $255 million. MPM sold two-thirds of its shares for $111 million, making 11 times its investment on these shares. Additional milestone payments and a potential future public offering could yield triple that take. “It would be hard to top this,” says partner Luke Evnin.

The big dollars have enabled MPM to invest in nontraditional ways, too. In 2001 Pharmacia was eager to close its Stockholm R&D center but faced steep severance costs and negative public relations in turning out 900 scientists. So in June of that year it spun off the operation to a syndicate of investors who put up $130 million in research funding for an 80% interest in profits from the lab. MPM contributed $35.5 million, and plans to throw in another $8 million. MPM partner Michael Steinmetz, who had run R&D at Roche in New Jersey, helped select the programs for BioVitrum to pursue or sell off. Amgen licensed several diabetes and obesity compounds in September for $86 million plus royalties. Sales of ReFacto, a hemophilia product marketed by Wyeth, bring in royalties of $68 million a year.

MPM has a publicly traded equities fund, but it is open to institutions as well as to well-heeled investors with $1 million to put up. Run by Kurt von Emster, a star manager from Franklin Templeton, the MPM BioEquities fund has already raised $300 million. Von Emster invests alongside the MPM venture team, and has access to MPM’s 9 analysts, 16 other partners and 17 advisory board members, throwing a lot of brainpower behind each buy or sell. Six analysts dedicated six months to analyzing publicly traded Rigel Pharmaceuticals, before MPM made a $20 million investment in May. Since then stock in the drugmaker is up 70%.

Gadicke’s team has had a few dogs, too. It put a combined $20 million-plus into two startups during the dot-com bubble. DoubleTwist ran out of money before it could prove that scientists would flock to its Web site to get the latest research software. MPM wrote down to zero its stake in Medical Self Care.

But if the early successes are any guide, these folks are worth watching.