Forget FAANGs – look to the US for the world’s best biotech

By Marek Poszepczynski and Ailsa Craig, co-investment managers of the International Biotechnology Trust

The development of not one but several Covid-19 vaccines in a mere matter of months has captured the imagination of investors. With the biotechnology sector firmly in the spotlight, investors are wondering how to access the lifesaving innovation on display.

However, biotech is a deep and complex sector, which requires extensive expertise to navigate. Scientific discoveries occur in all corners of the globe, but to gain exposure to the drugs providing solutions to the world’s most complex conditions, investors should look to US companies listed on the Nasdaq Biotechnology Index.

In order to understand why the US has become such a biotech behemoth, investors must follow the journey from brains to business.

All roads lead to America

Innovation often arises in cities home to renowned universities with strong research capabilities – such as Boston, London, Cambridge, Oxford, Stockholm, Paris and Basel. Companies are then formed to bring scientific breakthroughs to market. At this stage, financing and personnel requirements are limited and these small and privately owned companies typically remain based in their home market – where they are largely inaccessible to mainstream investors. We are able to gain exposure to early-stage biotech by investing in the SV Fund VI, which utilises the venture capital expertise of SV Health Investors.

After the innovation stage, the next step to launching a marketable drug is to conduct clinical trials. Large-scale testing in humans is expensive, leading businesses to seek additional finance from public equity markets. In the US, companies can find a wide pool of investors familiar with the sector. Hence, they flock to ‘the land of the free’, listing on the NASDAQ Biotechnology Index. Even companies that maintained incorporation in their home countries will often seek a secondary or dual listing in the US for this reason.

Companies working their way through clinical trials need to navigate complex regulatory requirements from the FDA and require an experienced on-the-ground management team – which can also be found in the US. Boston and San Francisco have become established biotech hubs – bringing together scientists, experienced financiers and business professionals, in close proximity to academic centres of excellence. With a history of venture capital, these places have built up unparalleled entrepreneurial ecosystems.

Finally, when it comes to commercialisation, the US private healthcare system offers more opportunities for making money, with higher pricing in the largest pharmaceutical market in the world.

Our International Biotechnology Trust has an 95% exposure to US-listed businesses, with just 5% located in the UK, EU and China. While the venture capital market is slowly maturing across Europe, and China is building up its distribution capabilities, we believe the US will continue to offer the greatest choice of high-quality biotech names for the foreseeable future.

Exploit sector swings

While the Nasdaq Biotechnology Index has risen by more than 50% since Covid-19 was declared a pandemic, consistent double-digit growth for the sector is underpinned by structural long-term dynamics that are uncorrelated to market movements. Indeed, the increasing need to address diseases in an ageing population will outlast current pandemic-induced hype.

However, the biotech sector can be turbulent at times, with generalists and retail investors trading on market sentiment. Therefore, it is crucial to know when to adjust to a high or low beta exposure.

Based on our outlook for the sector, we can adapt our weightings to different risk categories. We have a proportion of the trust in dependable profitable companies, another segment in high-risk development stage companies, and the final percentage in revenue growth opportunities. These are companies with an approved and launched product that are poised to become the next ‘big pharma’ but not yet turning a profit.

Opportunities in the latter segment are always appealing, as these assets are prime targets for acquisition by major pharmaceutical companies. M&A is a regular feature of the biotech market, with firms responsible for the ‘brains’ often looking to partner with listed companies with deeper pockets and distribution capabilities.

As a result of the pandemic, the biotech sector has boomed, and we expect the next phase of the cycle to feature consolidation. We are seeking to take advantage of this by utilising gearing to increase our exposure to small caps.

Identify undervalued opportunities

On a bottom-up basis, we look for reasonably priced companies meeting an unmet medical need, which are operating in a market with high barriers to entry and have a solid patent estate. We have a high exposure to rare disease treatments, where many businesses boast these characteristics.

‘Orphan’ drug treatments, designed to treat rare conditions, benefit from perks that are attractive from an investment perspective. In the US, these drugs receive seven years of market exclusivity and are easily reimbursed, with regular exemption from price controls. While this might appear controversial, the quality of life these treatments can restore is invaluable, as are the significant long-term savings for the healthcare system from replacing lifetime therapy.

Oncology is also an area of strong growth, driven by a better scientific understanding of the biology and pathology of cancers. Addressing individual cancers in a patient specific way may have direct effect on survival and quality of life, which would smoothen the pathway to regulatory approval and profitable pricing.