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Andrea Gentilini
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The Age of Biotech: Opportunities Grow for Healthcare Investors

The latest on our Novus Healthcare Specialist Portfolio, including industry trends affecting hedge funds—biotech, immunotherapy, and buyouts.

With election season heating up, healthcare has once again grabbed the attention of the political domain and the broader public. Prescription drugs, poor health outcomes, pharma executives and insurance are evergreen punching bags in Washington. One pocket of healthcare that escapes Washington’s ire tends to be biotech, the leading light of innovation in the space. The biotech sector was not immune from headlines, especially given the rapid price escalation of therapies for rare diseases. Thankfully, the commercialization of much of their research is done through strategic partnerships with big pharma, or via acquisition. This provides a nice veneer to the traditional outrage over drug prices. Nonetheless, the biotech sector had a raucous 2018, with stocks moving wildly, especially in the second half of the year.

Taking a step-back, everyone entered 2018 thinking it would be a banner year for biotech.  2018 was anointed as the year of M&A; tax reform provided the opportunity for repatriated pharma bucks to be put to good use (buying biotechs!). And yet 2019 may surpass 2018 in total M&A. While certain acquisitions (specifically in CAR-T and gene therapy) shook the landscape in early 2018, we saw what may be the last swan-song of the “four horsemen of biotech,” forever changing the sector.

Perversely enough, M&A in 2019 was catalyzed by the downturn in the latter half of 2018, creating a window of price levels for strategic large-scale acquisitions to “make sense.” Like many growth sensitive equities, the fourth quarter of 2018 was a tough period for performance. The Nasdaq Biotechnology Index took a +14% return through August, and summarily ended the year down 9%. The Novus Healthcare Specialist Portfolio had a similar downturn:

Figure 1: 2018 performance for The Novus Healthcare Specialist Strategy versus the Nasdaq Biotechnology Index

Market Opportunity After Washout

With the downturn across these risk assets in Q4 ‘18 came opportunity, and opportunists pounced. Kicking off the New Year, Bristol-Meyers Squibb announced the blockbuster acquisition of Celgene, one of the fabled four horsemen of biotech. This signaled the end of an era for one of the most successful biotech companies, which chose to blaze its own path and commercialize its own drugs. Driven by the success of REVLIMID, its blockbuster myeloma therapy, Celgene was able to take its scientific success and translate that into commercial profit, where many biotech companies may seek buyouts to maximize value upon regulatory approval of therapies. Celgene has been a prolific acquiror in the smaller cap biotech space, and this move led to a changing of the guards. Competitors followed suite, strengthening franchises through “medium” sized acquisitions. This included Roche’s acquisition of Spark Therapeutics, and most recently, Pfizer’s announced acquisition of Array BioPharma.

Continued Appetite for “BioRisk”

Investor appetite for risk in the biotechnology space continues to grow. This risk is not solely contained to public markets. The most recent quarterly report by the National Venture Capital Association shows that 2018 was the highest year of private market dollar activity in the sector:

Figure 2: Venture Capital Exposure (in $bn) by sector (https://nvca.org/)

Trends in Research – Focus on Immunotherapy

Backed by ample funding, progress motored on at an exciting pace, and large-scale change began to take afoot. There was an army of exciting clinical trial data revealed, including a rash of new therapies brought to market in the oncology and gene therapy space. Some data unfortunately failed to impress, specifically in the immunotherapy combination space, where there has been a focus of activity. Take for instance, IQIVIA’s global oncology trends report—as seen in chart 10, the immunotherapy research pipeline across biotech remains robust.

Novus Healthcare Specialists Portfolio Update

As we’ve written about previously, hot areas such as oncology, gene therapy, and neurology continue to command investor dollars seeking breakthrough therapies. We track these trends through the Novus Healthcare Specialists Portfolio, which includes public and private hybrid investors. This portfolio, which we mentioned had a rough go in the second half of 2018, started off 2019 quite strong, returning over 23% through May, versus a more tepid return for the Nasdaq Biotechnology Index (+3.3%).

Figure 4: Underlying composition of hedge fund managers’ public regulatory filings which comprise the Novus Healthcare Specialist Portfolio

As a brief refresher, this portfolio leans heavily towards biotech exposure, as can be seen through its risk exposure over time. Biotech exposure has only increased in the last few years. Hedge Funds tend to be adept at deploying exposures where profitable, as managers continue to focus their attention (and capital) towards the space:

Figure 5: Risk exposure by sub-industry for the Novus Healthcare Specialist Portfolio

Quarterly Security-Level Trends

There are a few interesting trends we observe in the portfolio as we ingested new public regulatory filings during the quarter on the managers whose public holdings drive the portfolio’s construction. First, the portfolio exited LOXO, a buyout. It also exited HRTX and SGEN. HRTX received a rejection from the FDA in late April due to manufacturing concerns over its post-surgical analgesic.

Figure 6: Q1 ‘19 Entries and Exits For the Novus Healthcare Specialist Portfolio

Meanwhile, the portfolio entered exciting therapy companies such as GBT and MRTX, as well as BHVN and PTCT. All have critical and important clinical trial updates approaching, which tend to be large catalysts for stock movements. For example, BHVN has an expected PDUFA date in the second half of the year to review BHV-0223, its clinical trial therapy designed to treat amyotrophic lateral sclerosis (commonly known as ALS or Lou Gehrig’s disease).

What’s Next? More Buyouts?

It seems like biotech speculation has centered around buyouts, after a raft of big-name IPOs surfaced without much turbulence. But perhaps the landscape has changed after CELG/BMY was announced at the beginning of the year. The Novus Healthcare Specialists Portfolio held several similar buyouts, including LOXO and the newly announced acquisition of ARRY. With AbbVie’s headline stopping announcement of its proposed acquisition of Allergan, the entire space is awaiting the next domino to drop. Will it be another one of the four horsemen? Will exciting innovators in the small and mid-cap space continue to attract larger suitors? Will clinical trial data hold up to lofty valuations, and what political ramifications will 2020 have on the space? We’ll find out. And I guarantee we’ll be writing about it—stay tuned.

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