Five funds to buy into biotech's healthy future

(Image credit: Test tubes © Alamy)

published 26 November 2019

It's easy to be bullish about the healthcare sector in general and the biotechnology sector in particular. Everyone wants to live a longer and healthier life and people are willing to devote more of their income to healthcare. As Geoffrey Hsu, the manager of the Biotechnology Growth Trust puts it, "we are in a golden era of innovation with a record number of new drug approvals in the US".

But then why does the healthcare sector in the US trade at a 15% discount to the market, having returned just 6.4% in 2019 compared with an S&P 500 return of 20%?

The bulls tend to gloss over three problems. Innovation has to be paid for, whether directly or indirectly in an insurance-based or a government-funded system. New drug costs, in particular, are politically sensitive even if the overall cost of drugs has been stable at around 10% of US health spending for decades.

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In the UK, there are more votes in spending money on hospitals, doctors, nurses and services than on drugs. Drug approvals are policed by regulators for whom it is easier to say no than yes. Finally, rules for drug trials can produce false outcomes with effective drugs failing but others with little benefit appearing to succeed.

Drug trials are skewed

All drugs have to be tested against a "placebo", an inert pill with no therapeutic value. Yet the "placebo effect", whereby a placebo can be surprisingly effective, for example in the treatment of allergies, can handicap the assessment of an active compound. Giving a sufferer of a serious condition, such as cancer, only a placebo when other treatments are available is unethical so trials will recruit patients for whom everything else has failed.

Yet most drugs work much better if administered early in the progression of a disease and often not at all if late. So the structure of trials is biased towards failure.

In March, Biogen suspended late-stage trials for aducanumab, a highly promising drug for the treatment of Alzheimer's. Medical progress in the treatment of Alzheimer's has been so dismal that success, in the opinion of Hsu and his colleagues, would have made it the biggest-selling drug in the world and opened the door to even better treatments. The Biogen share price fell by a third. Then, in October, Biogen announced that further examination of the trial results showed that high doses for extended periods had, after all, a significant therapeutic effect. The share price bounced by over 30%.

New technologies cut costs

Drugs trials are hugely expensive, but the industry is cutting costs through new technologies, such as gene therapy for rare diseases and genome sequencing for identifying targets in the treatment of cancer.

Also important is the cross-fertilisation of ideas and cutting failure early. Noel Fitzpatrick, a professor of veterinary orthopaedics, is a powerful and convincing advocate of the convergence of animal and human surgery and treatment. Treating tumours induced in rats has been proved to be much easier than treating naturally occurring ones in humans. Many trials that were successful in rats have failed in humans, at huge cost. While Democratic hopeful presidential candidates focus on the "excess profits" of drug companies, the regulator has sought, according to Hsu, to contain pricing through competition in recent years. This has meant promoting and rewarding innovative development, streamlining the evaluation and approval basis and being less stringent on efficacy and safety for initial approval. This has "reduced the time, cost, and approval risk for new drugs in development".

This doesn't guarantee an easy ride. But the future for investors in Biotech Growth Trust (LSE: BIOG), its sister trust Worldwide Healthcare (LSE: WWH) and competitors BB Healthcare (LSE: BBH), Polar Capital Healthcare (LSE: PCGH) and the International Biotechnology Trust (LSE: IBT) should be more in line with the long-term sector averages of 15% per annum for biotechnology and 12% for healthcare than the dismal average fund return of minus 8% in the last year.

Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.

After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.