Podcast: Is the biotech sector showing signs of life?
Is biotech in the early stages of recovery after suffering its longest ever downturn? Fund managers Ailsa Craig and Marek Poszepcynski discuss the outlook for the sector.
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[00:00:00.11] - David Brett
Welcome to the Investor Download, the podcast about the themes driving markets and the economy now and in the future. I'm your host, David Brett.
[00:00:23.21] - David Brett
Demographics are causing issues globally, in particular, the increasingly complex demands of a global population that's growing older, richer, and sicker, which is driving demand for healthcare services. Yet the biotech sector, which includes companies that could provide many of the solutions to the problems being created by ageing populations, has been languishing. In this show, I'm joined by fund managers Ailsa Craig and Marek Poszepcynski. We look at why the biotech sector might be struggling and the trends that could revive it. But in the first part of the show, we look at aging populations and the issues they're creating.
[00:01:07.20] - David Brett
So we mentioned at the top of the show about demographics, the challenges that we face with ageing populations and what they're posing to governments and businesses. Life expectancy, I found out the other day, 73 years as of 2023. So long, long way to go for quite a lot of us. That's a global average. But I also read quite a lot about poor diets and habits causing unhealthy lifestyle. So given all the headlines, how and why are we getting older?
[00:01:34.22] - Marek Poszepcynski
Really good question. I mean, medicines have improved the life expectancy of people globally. What we have seen smoking is coming down, so lung cancers and such diseases down. Vaccinations have improved, especially in the developing world. Even in the Western world, the life expectancy is increasing every year. We have tried to tackle diseases like cancer. I think, according to Cancer Research UK, we have doubled the survival rates in cancer the last 50 years, which is very, very promising. These stats are relatively old, so we probably have even better stats now. But also when we get all the wear and tear affects us, we start to get the disease. If you can see the population above the age of 65 globally will be 2.5 billion by the end of this century. Population above the age of 80 will be around 450 million by 2015, according to UN.
[00:02:36.21] - David Brett
That's an incredible amount. So despite some of the headlines, we are, in fact, getting healthier.
[00:02:41.11] - Marek Poszepcynski
Yeah, absolutely. What doesn't show in stats is also the quality of life aspects. It's a grim talking about cancer is a curse. But think about this way, life expectancy for those who actually get cancer is relatively long nowadays. You can have much better treatment options. If you go back 30 years, you have chemotherapy, which is horrendous treatment. Nowadays, you have more tailor-made medications. Even if you have disease, the quality of life is good. It's rarely mentioned in media, you talk about the survival, but the quality of the life you live is also very important.
[00:03:17.22] - David Brett
Okay, so we're hopefully all going to live a bit longer. What is the issue? What is the issue with ageing populations?
[00:03:25.07] - Marek Poszepcynski
Well, we put a lot of strain on society. If you look back, heart disease was a scourge 30, 40 years ago. Pharmaceutical industry came in, solved some of their issues. By that, we punt to the next level, which will be as soon we pass the age of 50, 60, cancer start to occur among us. We're lucky to get that old. Also by the next frontier is, unfortunately, central nervous system, Alzheimer's, Parkinson. If we can treat patients, just delay the disease onset and keep people out of hospitals, out of home care. Also, if you can have a quality of life, it means that you can actually work to the age of 70, 75, which will be a less strain on society.
[00:04:17.09] - David Brett
Okay, so just to pick up on some of the things you mentioned there, are there certain types of illnesses that we're seeing more of now that we weren't seeing, I don't know, maybe 30 or 40 years ago?
[00:04:26.20] - Ailsa Craig
Marek was alluding to this earlier. Ultimately, because of things like mechanical MedTech devices for heart disease, pacemakers and stents. People that would have died of a heart attack in their 50s are living to their 70s, and they're getting cancer and Alzheimer's. And we all know what the impact of that will be. A heart attack, you keel over and die. Whereas cancer and Alzheimer's, you live for a relatively long time, and you need a lot of intensive day to day care, a lot of hospital treatment. And where are the big bucks needed? Actually, it's hospitals.
[00:04:56.10] - David Brett
Yes. So that's where the rising costs are coming from because they're more difficult as well, I guess, to treat as you get older.
[00:05:01.24] - David Brett
Exactly. More difficult, more intensive care needs. Absolutely. And especially Alzheimer's, actually. And so we've seen a couple of drugs get approved for Alzheimer's, which have a very marginal effect on delaying the disease progression. But when you consider that that might stop a patient to go into a nursing home for six months, the savings to the system are astronomical. So it's worth paying for that drug, if that makes sense.
[00:05:28.12] - David Brett
What's the difference between what we're facing to what previous generations were facing?
[00:05:32.04] - Marek Poszepcynski
If you think about the previous generations, if we go back 100 years, we had a lot of children, many died early on. It's a security blanket. You have to have many kids to survive. The dependency ratio is very, very low. Very few actually reach the age of 65. Then we had the baby boom in the '70s. We have this demographic boom that helped improve the GDP and paid for the social welfare system in a way. But what's coming up now is that we get much older. Many people can live in retirement for many years, but also the birth rate is coming down. The dependency ratio has been shifting a lot. And if you see certain countries like South Korea, which have a birth rate below one per woman, but also in Japan, when statistically, they pay more for nappies for adults than for children.
[00:06:33.06] - Announcer
Incredible. And so what you're saying is not only are people living longer, there's not enough babies being born as well. So it's exacerbating the issue.
[00:06:41.12] - Marek Poszepcynski
Yeah, you can see this. It's a positive. We live longer. I wouldn't say that's a negative thing per se. We should be living 65 and then kill off and go home. I think it's a very positive thing. But think about this way. 30 years ago, when you were 65, you were very much out of the system anyway. When you meet people that are 65 now, you can hardly see that they are aging. They are very fit, many of them. I don't know. Eighty is the new 65. What do I know? What people are healthier nowadays?
[00:07:10.05] - Announcer
Okay, so we've got people living longer, not enough babies being born, and there's rising costs to go with it. Are there certain regions or certain countries where the issues are more acute?
[00:07:19.05] - Marek Poszepcynski
China, with their one-child policy, is one of the few countries that might become old before they get rich, and that's something that is debatable. South Korea, which I mentioned previously, the whole European Union is dependent on migration because we cannot cover the birth rates. But I know human mankind is very good at innovating away from certain things. We have solved these issues before. I know no doubt we will. The question is, will AI come in and solve some of these issues? Who knows?
[00:07:53.05] - Marek Poszepcynski
On Apple Podcasts, Spotify, or wherever you get your podcasts, you're listening listening to the investor Download.
[00:08:01.22] - David Brett
Okay, so that set up just makes it sound like this is a perfect storm for the biotech sector.
[00:08:10.06] - David Brett
And yet the biotech sector has been languishing behind equites since 2021. In fact, the current downturn is its longest in history. So, Ailsa, can you just paint a picture for us? Historically, how has the biotech sector performed against the border equity market?
[00:08:24.12] - Ailsa Craig
Yeah. So if you look at the long term, the biotech part of the healthcare industry tends to outperform the whole of the healthcare sector. Why? Because they're smidcap companies that are highly innovative. And then healthcare over the long term tends to outperform the broader market. That relationship is now in a disconnect, to your point. However, if you scroll back and look at the long term charts, you can see that the way biotech behaves is quite unique. It tends to go through a boom and then consolidation, and then a boom and then consolidation. And there's various different factors as to why that is. One is that the industry tends to have a discovery, for example, immune oncology or curing hepatitis C or making HIV a chronic disease. These are actual things that have happened. There's a lot of generalist money moves into the sector. There's a lot of excitement because it's a new market from nothing. That's when you get these booms. The time period that you've just mentioned is from an end of a boom. What was that boom? That was from the pandemic. Vaccines being discovered, treatments being discovered. Everyone was at home, working from home, called armchair investors and jumping on this bandwagon.
[00:09:36.21] - Ailsa Craig
So it had a big boom, and we're now been through a period of consolidation.
[00:09:41.09] - David Brett
This last downturn has been the longest in history. Why do you think that is?
[00:09:45.18] - Ailsa Craig
I think that's a really good question. I think it's gone in stages. So I was talking earlier about a boom and then consolidation. So the first leg down was probably valuations correcting. And then the next thing that hit the sector interest rates started rising, and that caused an even bigger leg down in the sector. Then what's happened since, we've had a long period of consolidation, again, flat market for biotech. There's been speculation, and I'm inclined to agree with this, that the obesity companies, Novo (Nordisk) and (Eli) Lilly, have sucked up a lot of the money that would normally have gone back into biotech. And another statistic, the market cap of Novo Nordisk is larger than the whole of the GDP of Denmark. And so there you can see where money is flowing, and I suspect That's where it's gone.
[00:10:31.07] - David Brett
So some of the characteristics we have seen before, the boom and bust. It sounds like the boom was heightened because of the COVID issue. But also you mentioned that. I just want to pick up the interest rate side of things. I wonder if you could just explain that a little bit more because people might not get that relationship.
[00:10:46.07] - Ailsa Craig
Absolutely fine. It's not because these companies have debt. It's because they are long-dated assets. So the revenues and profits that they expect to have are going to be 10, 15 years away. And when you value a company, you discount those cash flows from the future to today. And if the interest rate is bigger, that number is going to end up being smaller. It's as simple as that.
[00:11:05.10] - David Brett
And it also didn't help the Silicon Valley Bank collapse as well.
[00:11:09.24] - Ailsa Craig
Exactly. And that was very much linked to biotech companies. You're absolutely right. We have to point out that the interest rate cycle has changed now. The US are cutting rates. They aren't raising rates right now. Another reason why investors might become more constructive about the sector.
[00:11:25.14] - David Brett
The sector has been showing signs of life. What's been happening?
[00:11:28.17] - Marek Poszepcynski
To begin with, I think it's It's important to Ailsa's point regarding interest rates. It peaked at 5% approximately a year ago, and we saw that since then, the interest has come down and biotech has had a recovery. What also we have seen is financing has improved for biotech companies. They have easier time raising money, especially the quality companies. But you also see recent new public offerings, which is a good sign that the industry industry is in better shape than it was a couple of years ago. Coming back to the history is that during the pandemic, when it was a risk on environment, as we all know, a lot of biotech companies were listed, relatively early stage ones, and they inherently carry a high risk, and they have, subsequently, many of them have failed, and that left a bad aftermath for many biotech investors. But we have seen a lot of consolidations, mergers, so the industry is in much better shape and the productivity has improved.
[00:12:35.16] - David Brett
You just mentioned there that it left a bad taste in the investors' mouth. Has investors' sentiment changed yet towards the sector?
[00:12:41.21] - Marek Poszepcynski
That's a really good question. We tend to write a blog every month, and you can go and check that out. But what's important with that is that the industry is one of the most conservative in terms of investment. Once you invest in a biotech company, it takes 10 to 15 years to develop a drug. But the sentiment on the stock market can change several times during that period. You can have a very hot risk on environment, and the same company could be valued five times more than during the Nadir. It's the same project. It's very important to have gone through these cycles. What we see now is that, I pointed out, the financing is better, so in a more equilibrium state at the moment. I wouldn't say we are super positive, but we are not in what we like one year ago.
[00:13:31.21] - Announcer
Get in touch with us by email at schroderspodcast@schroders.com or visit our website, schroders.com/theinvestordownload.
[00:13:45.17] - David Brett
Okay, so it sounds like we're starting to come out of the bust phase, but you're still not convinced that investor sentiment has totally changed. So let's try and draw up some enthusiasm for them. Why should investors be excited about this sector?
[00:13:59.24] - Ailsa Craig
I think the biggest theme at the moment is probably M&A. This is a long term theme for innovative biotech companies in that it makes sense that pharma market can distribute. They've got huge cash piles that can get behind marketing a drug. What they're not good at is inventing a drug. R&D productivity has fallen over time over the last 30 years, and pharma has reacted by reducing R&D budgets. The inverse, so that's true for biotech, so they are the that emanate out of universities, they find a new mechanism of action, et cetera, et cetera, and they're born from that nimble environment. And therefore, you have this really good partnership, if you like, where pharma is in licensing or acquiring new drugs, and then either doing these large scale trials that biotech can't afford and then launching a drug which they're good at. So everyone sticks to their knitting, and it's a good relationship. What we're seeing at the moment is there's a big bolus of IP expiries at the end of this decade. $100 billion in one year will go off patent. One of those drugs, Quetuda, is $25 billion owned by Merck. So if they want to grow their top lines, they've got to replace these massive expiries at the same time.
[00:15:12.05] - Ailsa Craig
So I think that investors are expecting more mergers and acquisitions at the moment. They've got huge cash piles, and biotech companies have the drugs.
[00:15:22.17] - David Brett
And is any of it related to this demographic issue as well? I mean, are these biotech companies working as hard as they possibly can to help solve some of the issues as we were talking about beforehand?
[00:15:31.19] - Marek Poszepcynski
Yeah, if you want to be philosophical about it, of course, you want to address unmet medical needs because this is the area you can charge. It's the contract with society. If you can cure a disease, of course, you will be reimbursed and paid for it. Pharma is, of course, looking for treating diseases that were previously untreatable. I think it's worth mentioning that during the last decade, we have seen a doubling of number of clinical trials, which bodes well for the future. To your point, have the industry responded to the demographic pressures? Yes, they have. Number of ongoing or approved drugs also on the increase is very positive. I think between 60% and 80% of new drugs approved emanate from biotech or academia, which shows you to Ailsa's point that pharma has accepted their role of being the distributors and marketeers of this industry as biotech is the inventors.
[00:16:29.24] - David Brett
Okay, so there's a lot of positives there. We were talking about the valuations for the sector as a whole, certainly in the boom period, going skyrocketing. Where are valuations sitting around now?
[00:16:39.08] - Ailsa Craig
Much more normalized. We did see a point where 20% of biotech companies were trading less than the cash position in their bank. I would say that was probably in nadir. It was 2022, I think, that era. We're not at those levels now. Like Marek said earlier, it feels more like equilibrium, like normalized markets, stockpickers market, neither boom nor bust.
[00:17:03.04] - David Brett
Okay, final question then. Are there certain areas within biotech that investors should be concentrating?
[00:17:08.02] - Marek Poszepcynski
I think, yeah. Where the new innovations, there are a lot of new mechanisms being discovered in the CNS space. So that's central nervous system for things like depression and schizophrenia, where there hasn't been much innovation for many decades. But recently, a couple of companies have come out with various different mechanisms to address the pitfalls of antidepressants, for example, which take weeks to work. And there's also sexual dysfunction side effects. So what they're doing is trying to address those issues and have a fast onset of action, which is perfect for depression, because a lot of people who are severely depressed, you need to make them feel better straight away because they're at a suicide risk, for example. Secondly, I think a lot of innovation around the second generation I mentioned earlier, drugs for obesity. A lot of the drugs that are on the market now make people feel sick or actually make them throw up. So there's a lot of innovation there. Then third, I think cancer. This isn't something .... this never goes away, the innovation. We've seen so many steps forward for cancer patients. Thirty years ago, it was a very different area. Those would be the three disease areas that are quite interesting.
[00:18:16.11] - David Brett
Okay, great. Just one final question to the two of you. We mentioned before that investor sentiment you don't think has turned just yet. What do you think will end up driving investors to the sector?
[00:18:26.13] - Ailsa Craig
I think, like I said at the beginning, Basically, when you see generalists come back to the table is when there's been a market that's come from nothing. So not drugs replacing another drug that's existing, ie, for example, chemotherapy was very toxic, and now you have targeted therapies that are less toxic. That's not growing the size of the pie. Investors come to the table when the pie increases, and that's what we're seeing with obesity right now. That's a new market, and in fact, it's so big. So if every obese patient in America was treated with the current therapy, the drug bill would be the same as the whole pharmaceutical drug bill is today. So that's a massive market, and that's why we're seeing these valuations with Lilly and Novo. I think something from nothing, a new discovery, a new, very successful drug launch, those and lots of M&A. Maybe with the election behind us, the US election, people might have a bit more confidence and clarity. Classic things investors look for, certainty. That might be a period to relook at the sector.
[00:19:27.24] - David Brett
Ailsa and Marek, thank you so much for joining us.
[00:19:29.17] - Ailsa Craig
Thank you for having us.
[00:19:30.20] - Marek Poszepcynski
Thank you.
[00:19:34.08] - David Brett
That was the show. We very much hope you enjoyed it. You can subscribe to the investor download wherever you get your podcasts. And if you want to get in touch with us, it's schroderspodcast@schroders.com, and you can find out much, much more at schroders.com/insights. New shows drop every other Thursday at 05:00 PM UK time. In the meantime, keep safe and go well.
[00:19:58.20] - Announcer
The value of investments and the income from them may go down as well as up, and investors may not get back the amounts originally invested. Past performance is not a guide to future performance. Information is not an offer, solicitation, or recommendation of any funds, services, or products, or to adopt any investment strategy.
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