Biotech is a key Zeitgeist for the years to 2020 and beyond, invest via a fund that includes many of the companies that are already well advanced in developing the key technologies.

Biotechnology, the use of living organisms to develop and make products, is a vast field that spans many areas including pharmaceuticals and energy and, sometimes more controversially, reproductive systems and agriculture. It has existed for millenia but has seen especially rapid growth in the last few decades, as scientific discoveries have spread from the universities to the commercial world. Progress has been greatly accelerated by the digital revolution, as modern computer power and statistical tools allow biotech researchers to analyse likely outcomes before moving to the expense of physical experiments.

Aspirin was only the beginning

Healthcare has so far been by far the largest area for commercial application of biotech, which takes the chemistry of medicines to previously uncharted levels. Aspirin contains 21 atoms, while pharmaceuticals developed by biochemists could contain 25,000. And while doctors nowadays can tailor treatments only by choosing drugs from a limited list and adjusting the dosage level, in future some medicines may become completely personalised to be unique for every individual patient.

Some treatments from the modern era of biotech are now in everyday use around the world, for instance the synthetic insulin used by those with diabetes, which replaces the animal-based products in use until a couple of decades ago. Joachim benefits from some of the ongoing developments, such as the implanting of small devices that monitor and release measured doses. A large proportion of the current research effort is concentrated on treatments for cancer, which span the complete spectrum of development stages, from being already in use, to those in the clinical testing stage, and on to ideas at the more speculative stage in the laboratory. Tackling dementia, for example by aiming to reduce the plaque in the brain that is believed to be a cause of Alzeheimer’s, is still at this early stage today. So is the technique that would allow LiLi B to grow completely new skin (or even organs) to replace damage, rather than relying on grafts, or on transplants from others. Meanwhile, there is a growing body of research on medical uses of marijuana, with almost half the US states joining the list of jurisdictions that allow its use for medical and/or recreational purposes.

This scientific and technological revolution in healthcare has been accompanied by a revolution in industrial structure. While two or three decades ago the vast majority of commercial development of new drugs took place in the giant “Big Pharma” companies, today a large part of the early and some of the later stage development and testing takes place in small and mid-size companies. Many of these start life as unlisted start-ups, often in collaboration with universities, and then move on to be listed on exchanges such as the US Nasdaq. They may be bought out by Big Pharma or by other biotech firms before or after listing, or they may raise sufficient capital to grow to the size where they can produce and market the drugs they have developed and then move on to others. The result is that some of the biotech companies have grown to be giants in their own right.

Rising demand from emerging markets

The biotech industry has shown impressive revenue growth. Over the last 5 years to 2014 is estimated to have grown 10.8% per annum (Source: IBIS, cited by Deloitte). While any view of the future is subject to uncertainty, it does seem likely that it can continue to show rapid, double-digit growth. This would reflect the wide range of as-yet unrealised opportunities for new treatments, the financial and human capital deployed, and the apparent efficiency of the new science. To illustrate this last point, the success rate for biotech medicines in phase 1 clinical trials has been more than twice that for conventional ones (with s a small number of atoms). (Source: Mckinsey, see report link below). And while budgetary pressure may slow the growth of healthcare spending in developed countries, this is likely to be at least fully offset by rising demand from emerging countries.

For investors, biotech offers a heady mix of high growth potential and high volatility. Looking back, the fast growth in revenues in the industry has also been reflected in investment returns on listed securities. The Nasdaq Biotech index, in existence since 1993, has recorded average annual growth of 14.3% (from January 1995 to July 2016), compared to just 4.7% for the broad US S&P 500 index over the same period, but it has shown far higher volatility. This volatility can be divided into two broad types.

The first kind of volatility comes from very large movements in the prices of individual biotech stocks, with daily moves of 20% or more being observed fairly often, notably in response to good or bad news about the success of clinical trials, applications for regulatory approval, or potential takeovers. Investors can reduce the likely impact of these stock-specific events on their overall portfolio, by holding a well-diversified exposure to the sector that includes a large number of different companies.

The second type of volatility arises when the entire sector moves up or down together. A glance at a historical chart will show that this sector-wide volatility was especially violent in 2015, with a bubble-like rise that saw prices roughly double in the space of about twelve months, before collapsing. Factors contributing to the increase in prices probably included excitement over a series of successful announcements from a number of biotech companies, as well as the lack of investment opportunities elsewhere, given low interest rates and sluggish global growth. This in turn led to large amounts of money being raised for both listed and unlisted investment in the sector, which drove up prices, creating a momentum that encouraged yet more inflows. The bursting of the bubble may have been partially spontaneous, as investors started to take profits which damaged the momentum, although one specific adverse factor came from negative comments about healthcare pricing by politicians including Hilary Clinton. Abstracting from these specific causes, this can be seen as an example of the “Hype Cycle”, a phenomenon visible in new technologies and new opportunities dating back to railways in the 19th century and more recently in solar energy, dotcom companies and others. This is a pattern where the companies involved in the new sector suddenly become the focus of media reports and investor excitement, leading to a bubble which soon bursts, taking prices down to a level from which they show less dramatic but reasonably well-sustained growth over many years, with some volatility but not on the scale of the bubble. There seems a reasonable likelihood that biotech stocks are following this pattern and now have the potential for longer-term growth without price swings on the scale of 2015.

 

Valerie Plagnol

“Biotechnology investments are a strategic sweet spot. On the one hand they are no longer in the early stage on the other hand they have enormous growth potential.”

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