February 20, 2014

Breakthrough Therapies will Transform Healthcare – and Healthcare Investing

The cost of genomic testing has declined and so far therapeutic benefits have been relatively rare – but that’s changing @TimBliamptis @WeathergageTeam

First of two posts on healthcare investing.  We are increasing our allocation to life science investing.  In the reasons why hangs quite a tale.

Over the decade of the 2000s it became increasingly clear that structural issues made investing in biotech companies a high-risk, low return game.  The clinical trial process lasted a decade, and cost hundreds of millions or even billions of dollars. Even worse, outcomes were unpredictable, as was the regulatory environment itself. Early stage investors found their companies at the mercy of the capital markets in later rounds.

Against this backdrop only the savviest and most adaptable life science investors were able to produce a “venture return.”  One successful adaptation involved developing an understanding of potential corporate acquirers, which were armed with large M&A war chests and desperately needed fresh products. Investing in private companies that they knew to be on those M&A roadmaps produced some outstanding returns. Another successful strategy was to invest in development stage companies that were post-IPO via PIPEs.

Most recently, life science returns have ticked up on the strength of an ebullient stock market for life science companies. In 2013 the BTK rose over 50%, while the NBI rose a whopping 66%. The momentum continues into 2014, with both indexes up over 10% YTD at this writing. By our count, 33 life science companies went public in 2013. The number would have been higher were it not for deal fatigue among the relatively few institutional buyers of life science IPOs. By the end of the third quarter buyers were almost on strike due to exhaustion.

Seeing an attractive picture in the rear view mirror is, of course, not a good reason to increase exposure. Indeed, more often than not huge runups are often harbingers of declines to come.

So why are we increasing our allocation now?

We believe several disparate developments are converging to improve both the risk and return sides of certain life science investments. Portfolios built on these investments should outperform their peers – and should also outperform previous generations of life science venture capital funds. Whether they outperform the other options available to alternative investments remains, of course, an open question. We believe they are poised to do so in a way that is unprecedented.

Let’s start with the much maligned FDA. Their fundamental dilemma: would they rather be called in front of Congress to testify about approving a drug that actively killed voters or about a drug that through their non-approval potentially allowed voters to die for its lack? Thankfully, in 2012 Congress did us all a favor by authorizing some new accelerated approval pathways including one for “Breakthrough Therapies”, the  Food and Drug Administration Safety and Innovation Act (FDASIA) and one for antibiotics “Generating Antibiotic Incentives Now (GAIN Act)”. In addition, approvals under the Orphan Drug Act have accelerated, with 2011, 2012 and 2013 each setting successive records.

Congress has now set the table for faster, cheaper approvals of drugs that offer compelling improvements over existing (or nonexistent) treatments, particularly of life threatening conditions. This reform improves the risk return profile of certain potential compounds. The question is: how many such compounds are out there?

Here’s where things get really exciting.  Over the last two decades the cost of genomic testing has declined along a Moore’s Law like trajectory.  So far therapeutic benefits have been relatively rare – but as I will discuss in my next blog post, that’s changing.

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