The biotech bust: a case study in hype, hubris but now hope

The rout in the healthcare sector shows no sign of abating. Even during the recent market weakness, investors haven’t appreciated its defensive qualities, but have instead focused on the potential disruption to US healthcare from an unpredictable new administration. However, contrarian investors may spot opportunities in the gloom – by Cherry Reynard.

The MSCI World Healthcare index is down 7.5% over the past three months[1]. Over the past three years it has delivered an annualised return of just 2.6%, compared to 13.7% for the MSCI World. For biotechnology and healthcare investment trusts, the picture has generally been even worse, with half the seven-strong sector seeing double-digit losses over the past 12 months alone[2].

There have been pockets of strength. International Biotechnology trust, for example, has eked out an annualised return of 5% over the past three years, helped by M&A on some of its key holdings. RTW Biotech Opportunities and the more generalist Polar Capital Global Healthcare Trust also look stronger over three years. However, it has unquestionably been a tough environment, particularly within biotechnology.

Paul Major, manager on the Bellevue Healthcare Trust, says a lot of the weakness has been macroeconomic, out of the control of the companies themselves. He points out that healthcare has suffered from investor focus on technology, “healthcare as a sector is in the shadow of technology. If you’re a growth investor, you have generally preferred to be in technology.”

Biotechnology, he says, has specific challenges. There is a Covid legacy: “In 2020, the world was ending and the healthcare sector was popular. Lots of companies came to market and there was a huge IPO boom from 2021 to 2023. Lots of companies went public without clinical data.” The sector raised a lot of money and, as Major says, “there is a danger in giving scientists too much money. It leads to indiscipline.”

This led to real indigestion in the market – a perfect storm of hedge funds shorting, M&A drying up, venture capital companies not being able to exit. The market is still irrational, he says, with the market not separating good from bad, and apparently agnostic on whether a company has phase 1, 2 or 3 clinical trials, or a strong ultimate market for its drugs.

Ailsa Craig, manager on the International Biotechnology Trust, says that higher interest rates have also been a drag for the sector. Biotechnology and other high growth areas of healthcare are long duration assets, vulnerable to changes in funding costs. That said, the sector hasn’t responded favourably even as interest rates have started to come down.

The blame for that can be placed firmly at the door of the new administration. She says: “When Trump was elected, the sector rallied, because he was considered ‘industry-friendly’. It was felt that there might be more M&A and briefly, this started to happen. Our largest holding, Intra-Cellular, was acquired, we reinvested into Springworks and that was also acquired.”

However, the appointment of vaccine-sceptic Robert F Kennedy Junior as secretary of state for health and human services has sent the market into a tailspin again. Craig points to the firing of prominent FDA member Richard Marks and the appointment of Vinayak Prasad as head of the FDA’s Center for Biologics Evaluation and Research as destabilising factors.

This all sounds grim, but, as Craig says, the sector is now at “peak despair”. She adds: “The cycle is very pronounced within the biotechnology sector. Since 2001, we’ve had four or five of these boom and bust cycles. Because people struggle to value these companies, lots of people blindly buy when it’s in favour or there’s been a new discovery. You get a wall of money coming in, hyped valuations, companies IPOing far too early, no M&A because the companies are too expensive. Then there is a correction and a period of consolidation. As valuations become more interesting, pharma comes back and buys them, more companies IPO and the cycle starts again.”

She says for the time being generalists remain on the sidelines, but “we think this will reverse. We’re seeing M&A pick up. The door feels like it’s creaking open.” The sector has valuation on its side. Craig points out that there are a huge number of companies trading at less than their cash position. She adds: “We have never seen valuations this low on a cash to market cap basis”.

James Douglas, fund manager on the Polar Capital Global Healthcare Trust, says that the concerns over Robert F Kennedy Junior are legitimate but “we’re of the view that there are some sensible and constructive people underneath.” He says the FDA appears to be functioning normally even if there is disruption from the job cuts.

Trump’s deferral of tariffs on pharmaceuticals remains a problem, however, prolonging uncertainty for the sector. The market may continue to struggle until there is greater clarity. There is also uncertainty around the ‘most favoured nation’ agenda – Trump is looking to address the issue that the US pays more for the same drugs than other nations, illegal under WTO rules. This could put pressure on pharmaceutical companies’ revenues. However, it may also lead them to look for new revenue lines, which could stimulate M&A for the biotechnology sector. This may also help it address the wave of patent expirations coming up in 2028 and 2029.

Douglas says there are still long-term durable drivers for healthcare and biotechnology: “Innovation is not waning and this is still a strong point of healthcare investing. The headline area has been in weight loss management and its co-morbidities – heart failure, sleep apnoea – but there’s also been breakthroughs in respiratory disease, atrial fibrillation and oncology.”

Major points to areas within gene therapy that could be really interesting. Craig has switched the focus of IBT more recently: the trust had previously focused on oncology, but now has more in rare diseases. “Funding tends to be ring-fenced. There are often no treatments. They often affect children and they are often higher science, with vocal patient advocates. It flies below the radar. In contrast, oncology is very crowded, and it is more difficult to stockpick.”

This is a complex sector to navigate. There are short-term headwinds – the uncertainty over drug-pricing in the US and capricious policy-making are likely to create volatility. However, pricing, potential M&A and innovation are factors in its favour. Major says: “Investors need to look at it as a 10-year investment, but I can’t tell you when the bulk of returns will be made.”

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If you want to hear more, tune in to our pharmaceuticals and biotechnology panel discussion at 11am next Friday, 27 June, which will feature Paul Major from Bellevue Healthcare Trust and Marek Poszepczynski from International Biotechnology Trust. Click here for more details.

[1] https://www.msci.com/documents/10199/c41a73d1-9037-4dbd-a175-703d3bb77ae6

[2] https://quoteddata.com/sector/investment-companies/specialist-funds/biotech-and-healthcare/