Healthcare investing has always come with high volatility, primarily due to the elevated amount of macro noise surrounding the sector (drug pricing debate, interest rates, etc). While macro and fund flows drive short-term erformance, we remain convinced that fundamentals are the deterministic factor for prices in the long-term.
In this article, we aim to reiterate the key reasons why the emerging healthcare sector remains an important strategic allocation for growth investors with a long horizon. More specifically, in biotechnology.
Despite market noise, we are on the cusp of solving one of biology’s greatest challenges
As of May 2022, the biotech market is experiencing a significant drawdown with the Russell 2000 biotech index falling over -65% from its peak in Q1 2021 and the SPDR Biotech Index falling -57% over the same period. This correction marks one of the sub-sector’s largest in its history, second only to the genomics bubble in 2000.
However, valuation pressures did not slow innovation. The FDA, despite being resource-constrained by the pandemic, managed to approve 60 new drugs over 2021 which is in line with recent years. Importantly, the approvals included more advanced modalities, such as RNA, novel antibody technology, and cell therapies. While the high-profiled approval of Biogen’s Alzheimer’s drug (Aduhelm) remains controversial, it could incentivize other players to work on solving this terrible disease and attract investments. Elsewhere, a landmark moment occurred when Intellia reported human proof-of-concept data for in-vivo gene editing, unlocking a potentially potent modality to treat diseases in the future.
Deepmind’s AlphaFold program made a gargantuan step in the bioengineering research world in solving one of biology’s greatest challenges, which is to predict a protein’s shape (that decides what happens inside a cell) with high certainty. This ability to predict protein structures will be a significant boon for medicine, enabling quicker and more precise drug discovery. Indeed, mRNA being firmly established as the preferred modality for Covid vaccines was also the result of prior investments into research techniques.
Exponential growth that accelerates with every new biotech cycle
One of the best superpowers that innovative sectors have is exponential growth over time and healthcare is no exception. The graphic below shows the long history of medicine, where breakthroughs in the past have always created greater value (both monetary and societal) than its predecessors.
A key contributor to innovation today and in the future remains to be the ability to sequence a human genome. The first human genome sequencing project cost $1bn and took over 10 years to achieve. Today, the approximate cost to sequence a human genome has fallen to $1,000 and it only takes two days. This dramatic fall in cost and time provides a strong tailwind to its adoption, and consequently the drug discovery process. According to the data from the United States Patent and Trademark Office, the number of drug patents have switched to an upward course since 2010, evident in the ever-growing drug pipelines from companies.
On a broader perspective, global drug sales have grown steadily over the last decade and are expected to grow ~6% over the next five years, according to Evaluate Pharma. Of which, the market share of newer drugs is expected to surpass conventional/generic medicine in the coming years.
Current valuations only come about once every two decades
We find the drawdown within the emerging healthcare sector to be a reflection of negative exogenous factors, rather than deteriorating fundamentals in this specific sub-sector. Nevertheless, valuations have been priced to the xtreme, where many biotech companies are trading below cash, with some even in negative enterprise value. Price-to-sales have also fallen to levels matching the global financial crisis. Granted, the most glaring risks include the cash burn issues that many smaller-sized biotech companies face. We view the concern justifiable, which is why we have stuck to our approach to select active managers, who are aware of these risks and therefore adept to navigate this environment through deep due diligence.
In summary, we believe that the heavily discounted emerging healthcare sector represents a compelling opportunity for long-term investors to turn crisis into opportunity through actively managed portfolios, to capture these powerful secular trends that drive medicinal innovation.
If you are interested in finding out more about gaining exposure to any investment themes explored in this article, please email us at info@hawksburn.com
Written by Andrew Ng, Senior Investment Analyst, July 2022