Despite some delays in R&D activity (mostly for clinical-stage companies-) the biotechnology sector has yielded excellent performance recently. In the equity markets the major biotech indices have outperformed almost every sector and hit all-time highs in 2020. The sector benefited from the improved reputation in the eyes of the public on the back of its key role in the response to the pandemic. This sentiment is not unjustified as the pace of innovation remains high in addressing areas of unmet need. Currently, there is an exciting R&D pipeline filled with new scientific development on areas such as rare diseases, new cancer treatments and genetic medicine. Finally, the success and resilience of the sector is supported by its non-cyclical nature and the influx of capital the last couple of years, chasing a solid IRR as other asset classes such as fixed income yield low returns.
The sector is benefiting from being in the limelight with a strong IPO market and M&A activity. The continued pace of M&A activity (with the industry showing it is increasingly comfortable concluding deals remotely) was also positive for investors that are holding a well-diversified biotech portfolio as the deal activity pushes valuation multiples up.
The attractive backdrop for the biotech sector is enhanced by a supportive FDA (US Food & Drug Administration). In recent years, the US FDA has sought to accelerate innovation and in 2020 it approved more than 50 novel drugs, the second highest year for approvals in the last 30 years. In each of the last four years there have been approvals for more than 40 new treatments. This has led to enhanced focus of investment portfolios on emerging biotech where specialist biotech expertise can give them an edge over the generalist investor.
SMALL CAPS ARE BRINGING IT HOME
With a strong pipeline of clinical innovation and pending FDA approvals activity is set to continue in 2021. The current high IRR standards can be met by seeking early stage (i.e. seed or Series A/B/C phase) ventures with promising technologies that address clear clinical unmet needs. The figure below indicates the outperformance of the small cap focused Biotech Growth Trust versus BB Biotech, International Biotechnology Trust and the overall benchmark.
This trend has encouraged fund managers to have a significant allocation to emerging biotech companies. Partly, this is indicated by the growing mid and small cap allocations (50% or more per 2020) in the chart below taking Biotech Growth Trust, BB Biotech and International Biotechnology Trust as a benchmark.
However, we do note underlying valuations have increased significantly, especially in the small cap space. Hence, some investors may wish to consider taking profits. Throughout 2020, active investors have continued to increase their focus on the shorter end of the small to mid-cap biotech market, where innovation is arguably the strongest. While these companies may be at a relatively early stage, new technological and scientific advances bring about shorter development timelines, with modalities such as mRNA vaccines and gene editing swiftly moving from proof of concept to successful clinical trial outcomes.
MARKET OUTLOOK: BIOTECH IS MORE THAN A COVID-19 STORY
With the world’s focus very much on the coronavirus pandemic, biotechnology has arguably been more in the public eye than ever before. Treatments (such as Gilead’s remdesivir) and vaccines (Moderna, BioNTech/Pfizer, Novavax, Janssen et al) for Covid-19 have largely been founded on biotech innovation, even where they have been developed using the capabilities of major pharmaceutical companies. The focus on vaccine development continues, given the emergence of virus mutations, which may necessitate more frequent booster shots than had initially been expected.
However, biotech is more than just a pandemic story. The investment case for biotechnology and healthcare is underpinned by scientific advances and demographic factors. With life expectancy rising worldwide, as well as growing prosperity in developing markets, there is a greater demand globally for treatments for previously intractable health issues such as dementia (where a breakthrough treatment is yet to be developed). Meanwhile, conditions such as heart disease and cancer are increasingly treatable, with positive long-term prospects. An example at the cutting edge of biotechnology is the promising trial results for gene-editing treatments focused on chronic haematological disorders such as beta thalassaemia and sickle cell disease, with data showing efficacy that could ultimately indicate a cure for these life-limiting conditions.
The year 2020 has gone down in history as a northmost buoyant year for initial public offerings (IPO) for biotech raising more than $14B. M&A activity was more subdued as the COVID-19 pandemic peaked in the first half of the year, but then recovered in the latter half of 2020. Positive post-IPO performance fuels the market activity while also boosting bigger market caps. Meanwhile large pharma companies are battling to persuade highly prospective companies for an M&A instead of going public with expensive acquisitions or more early stage moves. This trend nourishes deal values and valuation multiples. Which in turn leads to higher lucrative returns for venture capitalists and ample stimulus to (re-)invest capital in follow-up funds. Overall, we deem that the outlook for the 2021-2022 period looks strong. With sufficient fresh capital, strong R&D momentum around new medical inventions and an open IPO/M&A window- biotech investments and exits are expected to continue at a healthy pace. In the long term, the key question that remains is whether the large allocation of cash to the sector will proportionally translates into improved patient outcomes and shareholder returns.