Managers of healthcare funds are always bullish, dazzled by the accelerating pace of innovation and the relentless increase in demand from rising, increasingly prosperous and ageing populations happy to pay more for a longer, healthier life.
Too easily, they forget the downside. Pharmaceutical patents expire 20 years after invention (much less from when the product comes to market), dysfunctional healthcare systems don’t want to pay up for new drugs or equipment and the regulatory process for approval is tortuous and unpredictable.
The result is a rollercoaster ride for investors depending on whether bullish or bearish factors are front of mind. Major companies seek to diversify across therapeutic areas and products but, for biotech and medical technology start-ups, the outlook is often binary.
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Success leads to fortunes being made for the scientists and early investors, universal fame and academic accolades, perhaps even a Nobel prize. Failure means ignominy and bankruptcy.
The origins of modern healthcare go back thousands of years to Hippocrates and the ancient Greeks, who first practised medicine in a manner that would be recognised today. The pharmaceutical industry, as opposed to herbal medicines, dates back to the late 19th century when Bayer first developed the aspirin.
The biotechnology sector dates back only to 1976, when a small venture-capital fund invested $100,000 in a start up called Genentech. Having failed to find a buyer for $100m, it listed in 1980 with its share price doubling on the first day to give it a market value of $530m. It merged with Roche at a valuation of $47bn in 2009. No wonder investors are easily attracted.
Biotech’s bear market
More recently, the biotechnology sector has been at a low ebb, after “the second-worst bear market in the sector’s history, losing 70%”, according to Woody Stileman, managing director of the RTW Venture Fund.
This is attributable to prior overenthusiasm for biotech, the threat of drug price reform under the socalled “inflation reduction act” in the US, and worries that falling share prices would lead to pre-revenue companies running out of cash.
But “macroeconomic and fear-driven drawdowns have always been followed by a strong recovery”, says Trevor Polischuk, a partner at healthcare specialists Orbimed. “The valuation of small and mid-cap biotech companies has been crushed compared to their big pharmaceutical company counterparts.”
Many of these companies face a patent cliff as eight top drugs with combined global sales of $100bn face the expiry of their patents within five years. The solution for them is to acquire biotech companies with promising products at a late stage of the clinical-trials process.
“There has already been a surge in merger and acquisition activity in the last year, with the number of deals nearly doubling and their value nearly tripling in 2022. There is a lot more to come,” he says, pointing to 11 deals so far in 2023, five at share-price premiums above 100%.
The pipeline of new products is growing rapidly. Polischuk expects the top 15 biotech-sourced product launches to generate $60bn of cumulative sales within ten years as a result of “a record number of molecules under development, up 70% since 2016.”
Big pharma is doing plenty of drug development itself, accounting for many of the biggest likely blockbuster drugs. Top of the list is Novo Nordisk’s obesity drug Wegovy, followed by Eli Lilly’s Mounjaro.
Key to the adoption of these drugs by healthcare systems is proof that the consequent weight loss from them reduces the incidence of diabetes, heart attacks and stroke. Progress in the treatment of Alzheimer’s has resulted in potential blockbusters from Eli Lilly and a Biogen-Eisai joint venture.
Improvements in cancer treatment “just keep coming”, benefiting AstraZeneca. Moderna’s Covid vaccine is estimated to have saved nearly two million lives in 2021 but investors are sceptical of further applications for its mRNA technology.
Its cancer vaccine shows promise, and other vaccines against flu, the Zika virus and HIV are in the pipeline. For these products and many others across the sector, there is a long list of potential catalysts in the next year from drug trials and regulatory approvals to drive the sector’s performance.
In the medical-technology sector Intuitive Surgical is developing a surgical robot and Boston Scientific new atrial-fibrillation equipment.
The sector remains undervalued
This acceleration in innovation and prospects is not discounted in the market. Specialist healthcare funds have done well over the last year but progress has ground to a halt in the last six months.
Two of the trusts cover the whole sector: Orbimed’s Worldwide Healthcare Trust (LSE: WWH) and the Polar Capital Global Healthcare Trust (LSE: PCGH).
The latter tends to be more defensive in difficult times so it has the better three- and five-year record but WWH’s performance has picked up strongly in the last year. With £2.4bn of assets against £460m for PCGH, WWH is much larger and longer-established.
A quarter of the portfolio is invested in biotech companies, mostly the smaller, emerging ones, and 33% in pharmaceutical companies; 39% is in “non-therapeutics” including medical technology and healthcare services, 8% in emerging markets and 7% in private equity. The shares trade on a 10% discount to net asset value (NAV) compared with 4% for PCGH.
The performance of WWH’s £370m sister trust, Biotech Growth Trust, has been disappointing compared with its rivals, International Biotechnology Trust and Bellevue Healthcare in recent years, though there has been a recent pick-up.
More interesting is a relative newcomer, the RTW Venture Fund (LSE: RTW), which listed in October 2019, raising just $15m of new money. Since then, RTW’s NAV has increased by 62% to $1.69, giving it £250m of assets, but its shares still trade on a 23% discount to NAV.
This is just a small part of total assets of $6bn managed by RTW, the main fund of which has seen compound returns of 24% since 2009. RTW describes itself as “science-led”, investing in companies early, even setting them up or providing development advice, and holding them through flotation to sale or scale.
A highly promising pipeline at Prometheus
About 25% of the portfolio is in private equity but another 50% is in listed companies that were bought when private. For example, its largest holding Prometheus (15% of the portfolio) is being acquired by Merck for $10.8bn.
RTW invested in late 2020 on a $400m valuation prior to its listing six months later. Though it has no commercial product, Stileman describes the data from the Phase-2 trials (the second of three main stages of clinical trials) for its auto-immune lead product as “astonishing”.
Merck is thus paying a 75% premium to Prometheus’s pre-bid share price and RTW has multiplied its money “about 20 times”.
Stileman also enthuses about Rocket Pharmaceuticals, a $1.5bn listed company established by RTW and Orchestra Biomed, a revenue-generating medicaltechnology company which RTW took public this year.
Medtronic has partnered with its pacemaker upgrade, designed to make them more efficient and longerlasting. The shares ended the first quarter up by 90%.
There are duds, Stileman admits, but RTW’s success rate is around 60% and the scale of gains on the winners dwarfs the losses on the failures. Its performance does not justify its discount to NAV. While investors will want to put most of their healthcare money into WWH or PCGH, some room should be left for RTW.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+.
Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts; two directorships are still active.
After 39 years in financial services – including 30 as a professional fund manager – Max took semi-retirement in 2017.
Max has been a MoneyWeek columnist since 2016 writing about investment funds in magazine and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications.
See here for details of current investments held by Max.
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