In the low-growth environment we are currently living in, one should expect that fast-growing sectors command a premium. However, what we have recently observed is a rush to low-growth, high-dividend stocks (so-called “bond proxies”) in a capitulation by investors crowded out of the bond market by central banks.
These yield-starved investors have reluctantly bought the narrative that in the current low interest rate environment “stocks are the new bonds”. Therefore, they have no other choice than to accept higher volatility in return for a dividend. At the same time, equity investors have largely shied away from high-growth stocks and concentrated on high-quality stocks instead.
This reflux of investor flow has created a number of investment opportunities in the riskier end of the investment spectrum, with Biotech being the outstanding candidate.
Along with the S&P, the Nasdaq Biotechnology Index reached its peak in 2015, and started to correct in tandem with the US market, falling by almost 40%. However, whilst we saw a rebound in the broad equity market to new highs, biotech stocks have not managed this. While it is true that the index had had an incredible run (with a threefold increase since 2012), it was largely a consequence of the sector delivering up to its promises. New treatments hit the market and this enabled companies to make profits, subsequently triggering successive waves of IPOs and M&A deals, a result of Big-Pharma companies realising that it is a smarter strategy to handsomely pay for successful biotech companies instead of funding risky R&D ventures.
The main trigger behind the sector’s reversal was a tweet from Hillary Clinton promising to tackle the high cost of prescription drugs, following several scandals of price excesses in the industry. Now that Clinton is out of the equation, uncertainty has decreased, although it has not completely disappeared. A key element of Trump’s program is to scale back government intervention. However, during his campaign, he also mumbled some “me-too” drug price controls.
This aside, current valuations still offer a good entry point for investors who have a long-term investment horizon as the sector’s fundamentals remain very strong. The industry is not in a maturing but rather a reacceleration phase, akin to the web 2.0, but with less hype. Growth is driven by an expanding array of scientific discoveries (DNA sequencing, immunotherapy, stem-cell and gene therapies) powered by a convergence between biochemistry and the digital revolution. This enables both a reduction in costs (DNA sequencing costs are expected to drop from $100m in the year 2000 to $1k) and new ways for delivering treatments (personalised medicine, nano-robots). Moreover, some of the most wide-spread diseases without a definitive cure (Cancer, Alzheimer) are partially age-related. Coupled with an aging population, this translates into a huge market size.
If the urge you are now feeling to buy biotech stocks pales in comparison to that of buying Apple shares after watching Tim Cook introducing a new gadget, behavioural finance can explain to you why. As individuals, we prefer stories to analysis, and Biotech’s unappealing domain is that of deadly, rare or devastating diseases that require a very high level of scientific knowledge to be understood. In contrast, it is easy to get excited with the disruptive potential of a beautifully designed and easy to use iPhone, without having an engineering background. To overcome this excitement deficit, the best catalyst for the sector would surely be to discover another drug as sexy as Viagra!
Fernando de Frutos, MWM Chief Investment Officer
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