After producing some stellar returns in recent years, biotechnology companies have sold off heavily – leaving specialist funds sitting on some significant short-term losses – but could the niche area be set for a rebound in the near term?
Over the longer run, the biotechnology sector has been a rich hunting ground for investors. FE Analytics shows that the Nasdaq Biotechnology index has made a 199.78 per cent total return over the past five years; in comparison, global developed market equities (represented by the MSCI World) have risen 60.88 per cent.
But as the graph below makes clear, this has hardly come with the smoothest of rides for investors, with steep corrections a frequent occurrence. Our data shows that Nasdaq Biotechnology’s annualised volatility over the past half-decade stands at 20.91 per cent while the MSCI World’s has been 10.36 per cent.
Performance of indices over 5yrs
Source: FE Analytics
The past 12 months or so have proven to be especially difficult for biotech stocks with the index now down close to 27 per cent since its peak in July 2015. Global equities have managed to eke out a 3.10 per cent positive return over this time.
This has prompted a period of weakness in open-ended funds and investment trusts that focus on this part of the market. The biggest fall has been seen by The Biotech Growth Trust, which has lost 31.77 per cent, while the best performer – Polar Capital Biotechnology – is still down 19.89 per cent.
OrbiMed Capital’s Sven Borho, portfolio manager on The Biotech Growth Trust, said: “The initial weakness in biotechnology stocks was precipitated by negative news reports in the summer of 2015 about a small specialty pharmaceutical company suddenly increasing the price of an old drug for parasitic infections by 5,000 per cent.”
“US presidential candidate Hillary Clinton responded to this ‘price gouging’ by proposing new regulation that would lower drug prices. Subsequently, several other presidential candidates have suggested legislation to contain drug costs and the US Congress has held hearings to discuss drug pricing. The drug pricing headlines negatively impacted investor sentiment about biotechnology and the drug sector generally.”
In addition to this general headwind, Borho notes that a number of stock-specific issues have hit some of the sector’s most popular holdings over the past year.
These include a drop in Biogen’s share price on the back of slowing commercial performance of its multiple sclerosis drug Tecfidera after a rare side effect was discovered while GW Pharmaceuticals suffered from investor risk aversion ahead of results of a Phase III trial testing Epidiolex, a derivative of marijuana, for paediatric epilepsy.
Performance of trust vs index over 1yr
Source: FE Analytics
While the opening months of 2016 have been tough for biotech investors – the Nasdaq Biotechnology index’s falls in the first three months marked its worst quarter in almost 14 years – Borho added: “We believe that the fundamentals of the sector are little changed and we believe that the sector will recover as concerns about drug pricing dissipate.”
“While we acknowledge that strong pricing power is an important factor for biotechnology business performance, we believe the sector’s growth is fundamentally driven by innovation and the approval of novel drugs. Most of the biotechnology drugs on the market or in development target severe diseases with high unmet medical need, and are differentiated from existing treatments by higher efficacy or better safety.”
The manager believes that efforts to control drug pricing in the US will not pass into law in either the new or medium term, regardless of who is elected president later this year. However, he concedes drug pricing could remain a topic of interest during the presidential campaigning season, which could act as somewhat of an overhang.
“As long-term investors, we remain focused on the sector’s strong fundamentals,” he said. “With attractive valuation and abundant clinical and regulatory catalysts, we believe that the sector is well positioned to rebound in the second half of 2016.”
Adrian Lowcock, head of investing at AXA Wealth, says that the biotechnology sector was overdue a correction following its strong run, which had driven valuations to “pretty punchy” levels after a bout of M&A frenzy.
He is less than certain that the sector will escape further regulatory pressure in the US and as such is cautious on its outlook for the near term.
“Indeed, the sector could be under the spotlight in 2017 should Clinton win the US election later this year. Given this uncertainty I would be wary of the biotech sector and prefer the broader healthcare sector,” he said.
“Biotech is one of those sectors, similar to mining and oil exploration: they have a few years of stellar performance as investors get excited about future potential earnings, but then it takes longer for that potential to be realised. The biotechnology sector is going through a transformation as technology is used to release that potential but much of that opportunity is priced in considering it is a risky asset class.”
Furthermore, Lowcock suggests that valuations can hardly be seen at bargain basement levels.
Performance of indices over 10yrs
Source: FE Analytics
“Valuations certainly look more attractive than they did a year ago, but have only dropped back to late 2014 levels, when the biotech bull run had already been going for several years. As such investors are not getting back in at the bottom so are paying a premium to invest in this asset class,” he said.
“The risk of investing in sectors like this is getting caught out when the bubble bursts, this sector is very speculative and subject to high valuations which means overpaying for growth. Investors could make money investing in this area as there will be potential winners but they should remind themselves of the over enthusiastic valuations reached during the dotcom bubble and act accordingly.”
