We’re partial to a spot of thematic investing here at MitonOptimal. In addition to the deployment of clients’ capital along traditional geographic lines, our preferred equity funds include allocations to managers whose strategies are aiming to tap into specific secular (long term) trends that are not subject to the cyclical or seasonal influences which affect most markets or industries. Among our current picks within this portion of our portfolios is a specialist biotechnology fund.
As the chart below shows, the biotech sector’s long-term performance has, by most measures, been pretty spectacular, both in comparison to the global equity index and versus the wider healthcare sector – itself no slouch in relative performance terms. As evidenced by our quantitative analysis, however, heightened levels of volatility and downside deviation when compared with the broader market mean that performance over shorter periods can be somewhat “lively”. It is for this reason that our allocation to biotech within a typical portfolio is proportionately smaller than a standard equity position.
MSCI ACWI Biotechnology Index vs MSCI AC World Index and MSCI ACWI Healthcare Index in USD
Many of the drivers that have made healthcare a popular and successful theme among growth-oriented equity investors – ageing populations in the developed world, expanding middle classes in emerging markets, innovation – are present in both biotech and are amplified in terms of their potential impact on the sector and companies within it.
As far as innovation is concerned, undoubtedly the most important development has been the mapping of the human genome and the subsequent spectacular decline in the cost of DNA sequencing. It is remarkable to think that, since it was first achieved in 2003 after a fifteen-year $2.7 billion research programme and became commercially available for $300,000 three years later, it is now possible to sequence an individual’s genetic fingerprint for less than it costs to fill up the fuel tank of a family car. This decline in cost, in combination with the power of big data, a supportive regulatory environment and an element of pricing power, means that it is now possible to develop life-changing drugs to treat conditions for progressively smaller patient numbers in an increasingly cost-effective manner and over shorter time scales.
Despite this transformational impact on the sector over recent years, the “long shot” or “jam tomorrow” perception of many investors – that the biotechnology industry consists of small, unprofitable, one-product companies that burn through piles of cash over many years on their way to a binary regulatory outcome with a limited rate of success – persists. The reality, meanwhile, is far removed from that with metrics (17.5x historic P/E, 8.2x P/BV, 14.5x P/CF and a 1.86% dividend yield) that are entirely in keeping with a $1 trillion market cap high growth industry.
As the result of these and other factors, M&A activity has featured prominently within the biotech sector; thanks to relatively modest valuation levels for what is such a dynamic industry, it’s often cheaper for “big pharma” to acquire drugs by takeover than develop them through the conventional R&D process themselves.
All of which makes for a compelling long-term investment case in our view which, all things being equal, is likely to remain a feature of our portfolios’ equity component for the foreseeable future.
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