Transforming personal finance since 2011

#59 — Biotech: Another higher risk asset class to consider?


February 18th, 2020

By Andrew Craig

Reading time: ~ 14 minutes

This article is part 5 of a series: Part 1 | Part 2 | Part 3 | Part 4

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This is my fifth article in a series that has been looking at a powerful and elegant idea for thinking about how you might invest: “100 minus your age”.

As a very quick reminder of the story so far:

In the first article, I explained how you might use a simple calculation of “100 minus your age” to establish the relative percentages of your wealth and ongoing savings that you might allocate to “defensive” vs. “aggressive” investments. To recap what I said given what an important point it is:

“…as you get older, you need to be thinking more about the return OF your money rather than the return ON your money. Not losing money becomes increasingly important as we get older. The reasons for this should be fairly obvious: If you are 30 and have built an investment pot of, say, £10,000 – a stock market (or bitcoin) crash might reduce that pot to £5,000 perhaps. This isn’t great but it is clearly a great deal less problematic and stressful than if you are 60 years old and the £1 million you have spent a life-time building falls to £500,000 in the same scenario, not least given that you will need this money reasonably soon to fund you and your family in retirement."

So – “100 minus your age” suggests that if you’re 30 years old, you might have 30% of your wealth in “defensive” things and 70% in “aggressive” things. If you’re 70, it would be the other way around. I then also looked at a couple of options for the “defensive” proportion of that calculation, including our Fund.

In article two, I looked at some key ideas to maximise your chance of succeeding with this approach to investment – most particularly the difference between “investing” and “trading”, the importance of ignoring the news, the fact that investment success is far more about admin’ than what you invest in and, the fact that you probably only need to do that admin every five years or so.

In the third article in the series I looked at two “keeping it simple” options for the “aggressive” part of your investments: The S&P 500 and the MSCI World indices – both of which have returned anywhere between 8 and 10% over the long run.

In my fourth and most recent article I then looked at smaller company investment – where average annual returns in the UK have exceeded 15% for the last sixty years – a fact that is very little known in the general population.

As promised, in today’s piece, I’m going to start to look at some other ideas for higher risk / “aggressive” investment, beginning with the biotech industry. For anyone who may not be familiar with what “biotech” is, Wikipedia describes it as

“...the broad area of biology, involving living systems and organisms to develop or make products", or "any technological application that uses biological systems, living organisms, or derivatives thereof, to make or modify products or processes for specific use”.

Why Biotech

Long-term followers of my output (on social media platforms like Twitter for example) may be aware by now that I have two main roles: In addition to what I do at Plain English Finance, I am also a Partner at a boutique investment bank in London which specialises in biotech and life sciences.

I have been a specialist biotech banker (with a ‘b’ 😉) for more than five years now. In that time, I have met with dozens of life sciences companies and a similar number of investment firms from all over the world. Taken together, those investment firms speak for more than a trillion pounds of investment capital.

In the last year or so – I have been giving a presentation to those investors about the structural merits of biotech as a sector. As I say on the first page of that slide deck: I see a “once in a generation” opportunity in life science investment. I’m obviously “talking my own book” here but I do believe there are a number of compelling reasons that the industry will quite likely create the next handful of companies valued at the kind of levels currently enjoyed by the likes of Apple, Amazon and Alphabet (Google). Tech 2.0 could well be supplanted by biotech 3.0 in the next couple of decades and this would suggest there could be significant upside in the sector.

Below are five of the drivers for this potential upside that I highlight in my presentation:

One: Equity market momentum.

The biotech sector, as measured by the NASDAQ Biotechnology index, has produced average returns of just over 14% per annum for ten years. Momentum is important in equity investment (just look at those FAANG stocks and the S&P 500). Biotech has been one of the best performing stock market sectors of the last decade, yet I would argue still hasn’t gone “mainstream” in the way companies like Apple, Amazon Facebook and Google have. To a certain extent, the sector’s stock market success has also been something of a US-only phenomenon so far. I would argue that the rest of the world has yet to really take the sector to heart – particularly the UK and Europe (China is a different story as I mentioned in my last article). As more investors from around the world wake up to the sector’s potential and more companies deliver real commercial value, this performance could well continue and even accelerate. (Although I must highlight that past performance is not a reliable indicator of future performance).

Two: The science.

The second driver for the sector is quite simply the fact that the science is getting to a point where reality increasingly looks like science fiction. Sir Arthur C. Clarke (the British author who wrote “2001: A Space Odyssey”) said:

“Any sufficiently advanced technology is indistinguishable from magic.”

…this isn’t far off what is happening in the biotech industry at the moment. I see it every month. This exceptional technological progress is being driven by three related and complementary exponentials: Fall in the cost of sequencing a human genome, fall in the cost of processing power (Moore’s law) and, related to this, increase in the ability of R&D scientists, clinicians and regulators all over the world to collaborate using technology.

Moore’s Law and the cost of sequencing a human genome

Moore’s law is the basic idea that processing power per dollar or pound spent doubles every 18 months. You can see from the chart below that this has been the case for more than 120 years (utterly astonishing when you think about it).

Source – Steve Jurvetson

Top US VC investor, Steve Jurvetson has described this as:

“…the most important graph in human history.”

I agree with him. As the underlying driver for literally all of our technological progress, Moore’s law has been the single most important factor for human progress overall for more than a century. I believe that this will continue to be the case. At the most fundamental level, the continuation of Moore’s law will be vastly more influential on our day to day lives in the decades ahead than any of the noise that our media obsesses about every day, whether Brexit, Trump, Iran or Coronavirus.

Moore’s law is an utterly extraordinary thing, a testament to the phenomenal ingenuity of our species and nothing less than a source of great hope for our future. Amazingly enough, however, there is a chart from the biotech industry that has been leaving it for dust for more than a decade: The fall in the cost of sequencing a human genome.

Source - National Human Genome Research Institute, NIH

This chart shows that the cost of sequencing a human genome has fallen from $100 million to less than $1,000 in fewer than twenty years. The real picture is even more astonishing. It is difficult to estimate the precise cost of sequencing the first ever human genome, but it was anywhere between $3 and $5 billion dollars in today’s terms and took about fifteen years to do.

Today there are companies who can do it in a few hours for as little as $200.

From fifteen years and $5 billion to a few hours and $200. Utterly, utterly incredible – and a stat that far too few people have the foggiest idea about. This reality has far reaching implications for our ability to fight disease and find effective cures for things like cancer, COPD, diabetes, Alzheimer’s and dementia and, indeed, any and every other disease known to man (eventually).

(As an aside – I would highlight that this kind of phenomenon can also be seen in places like the cost of solar power, quantum computing technology, engine efficiency, chip design and on and on. This reality will very likely have extraordinarily positive and powerful consequences for us all – and sooner than most people realise).

So - the science is amazing, and reality increasingly looks like science fiction. Innovation is developing exponentially. I would suggest that equity value creation will quite likely follow the same trajectory – certainly if the evidence of history is anything to go by – although I have to explicitly highlight that past performance is not a reliable indicator of future performance of course.

Three: The demographics.

At the same time as the science is developing at such a blistering pace, the need for and demand for healthcare is exploding for a number of very powerful structural reasons. All over the world, populations are ageing, getting dramatically more obese and getting wealthier.

Most diseases are diseases of age. More than 75% of cancer cases are diagnosed in people over the age of 55 and the risk increases steadily as we get older. This is also true of many of the other major diseases. As a result, as populations all over the world live longer, their demand for healthcare mushrooms.

The same is true of obesity. In most developed economics today, anywhere from half to two-thirds of the population are classified as obese. (The developing world is doing its best to catch up with us too sadly). Just as with age, obesity significantly increases rates of illness. Both of these factors have driven a massive increase in the demand for all kinds of healthcare products and services and these factors are getting stronger every year.

It is also the case that wealthier populations spend more money on healthcare than poorer ones – because they can afford to. It wasn’t that long ago that most of the world’s population had no access to healthcare whatsoever – it was the preserve of a privileged few in the developed world. This has been changing rapidly. Today, billions of people all over Asia and in Latin America and even some of the wealthier bits of Africa have access to decent healthcare services and drugs. This phenomenon is also developing exponentially.

Four: “Equities 101” – valuation, cash generation and M&A.

This is arguably a more “specialist” point than the three I’ve made so far and a bit less intuitively understandable for someone with no training in financial analysis, but – for what it is worth - biotech companies are cheaper than many investors think and exhibit a number of attractive equity fundamentals: Significant pricing power, high margins, long product cycles and high barriers to entry thanks to their intellectual property (patent-protection).

Perhaps more important from a pure investment perspective, they’re also sitting in a sector with unprecedented financial firepower. Last year, leading accountancy firm, Ernst & Young, estimated that there is $1.2 trillion of cash available to large pharma and biopharma companies for investment and M&A (Mergers & Acquisitions). Pricewaterhouse (PwC) has estimated that there is another $1.5 trillion in the private equity sector which could go to work funding life science companies.

What this means, as far as I’m concerned, is that there is a great deal of money available to develop that science I mentioned above and, potentially, to bid up the prices of the companies involved. There is also what you might call an “M&A put” supporting smaller biotech companies - that is to say that there are likely to be lots of potential buyers for anyone who can demonstrate they have something. This reality is stronger in healthcare and biotech than in nearly any other economic sector given these financial firepower numbers.

Five: An improving regulatory environment.

On average, getting a drug to market costs nearly $3 billion and takes about ten years.

This enormous cost and time requirement is primarily a function of the regulatory requirements of getting a drug approved on both sides of the Atlantic – by the FDA in the US and EMA in Europe. This is one of the biggest challenges for biotech companies – particularly small ones who are less able to deal with the enormous costs and time required before it is possible to actually make any money – for obvious reasons.

Anything that happens to speed up this process and / or reduce costs, is highly beneficial for the value of the sector. Happily, the direction of travel in this respect in recent years has been positive. Regulators all over the world are better funded, politically empowered and increasingly comfortable with complicated “bleeding edge” science. You can see the impact of this reality on new drug approvals in recent years in the chart below that plots the total number of drugs approved by the FDA between 2008 and last year.

CDER - Center for Drug Evaluation and Research & Statista

This chart shows what has happened in the US. The same thing is happening around the world, more or less.

Taken together I think the five arguments I have made above make a pretty compelling case for biotech investment in the years ahead. To be absolutely clear as I am bound to be by the Financial Conduct Authority - this is just my opinion and should not be taken as personal investment advice!

Active vs. passive again…

Just as was the case with smaller companies in my last article, if you do want to add some biotech exposure to the aggressive proportion of your investments, there are a number of active and passive funds available with which you can do just that.

As an example of the sort of thing that is out there, you can see from this link that three of the London listed Investment Trusts in the space have returned more than 330% over the last ten years.

As I hope I have made clear before, I can’t provide specific investment recommendations – so you will have to do your own research - but I hope this article has been useful as an overview of some of the fundamentals that could well drive a great deal of value creation in this sector going forwards.

To conclude

So that is it for today. In these last five articles, I have explained why “100 minus your age” could be a useful tool to use when getting your finances sorted and given you a handful of broad-brush ideas about what you might do with the “defensive” and “aggressive” components that result from this approach.

As I have mentioned a few times over the course of this series, there are a number of other “aggressive” investments which I intend to write about in the fullness of time. This will likely include bitcoin and crypto, robotics, nanotechnology and AI (Artificial Intelligence) and possibly things like the more obscure commodities out there - uranium, thorium and rare earths for example.

This having been said, this five-article series has run to more than 13,000 words already in 2020 and I think gives you enough of a framework in terms of how you might think about using something as fundamental as “100 minus your age” for the time being.

Going forwards, I will cover those other types of higher-risk “aggressive” investments, mentioned above, on an ad hoc basis as and when I find the time and the inspiration!

I hope you found this series useful.

If you did and you’d like to hear more and join several hundred other folks discussing such things in real-time, please do consider joining our How to Own the World Community.