Biotech Has Fallen Hard. Now Could Be a Good Time to Buy.
The market is so picked over today by analysts that there are few areas where an active manager can find mispriced stocks to beat an index fund. Biotech is one of those areas, and now is a good time to be investing in it.
Consider that the potential for most biotech companies isn’t what their current earnings or valuations are. It’s whether they will have positive test results for a potential blockbuster drug, and then whether the Food and Drug Administration will approve the drug for sale. That isn’t easily discernible by quantitative screens seeking companies with cheap valuations, or by the average Wall Street analyst trained to read income statements and balance sheets.
Andy Acker, manager of the top-performing Janus Henderson Global Life Sciences fund (ticker: JAGLX), illustrates the importance of specialized knowledge in the sector: “We have 10 senior investment professionals [on our healthcare team] with a combined over 140 years of experience, including three Ph.D.s and an M.D. who are here to help us really differentiate between the drugs that are likely to work and those that are likely to fail.”
Today, that kind of expertise is crucial. The broadly diversified SPDR S&P Biotech exchange-traded fund (XBI) is down more than 50% from its February 2021 peak of $174 a share, to $83 a share, after two brutal years for the sector. Biotech dropped in 2021 because, after the Covid crisis caused all healthcare stocks to surge in 2020, there was an excess of dodgy biotech initial public offerings, which subsequently collapsed. But rising interest rates in 2022 only made matters worse. Many biotech companies need to borrow money to keep their research operations going while they’re in the drug-development stages.
But now valuations are attractive, rates could be close to peaking, and opportunities are plentiful—if you can find the right stocks.
“Last year was a year of positive [drug clinical trial] data, and this year could be the year of new product launches,” says Acker. “The FDA has 75 new medicines pending approval decisions. So this could be the year of the most new-product approvals of all time, as the previous high was 59 drugs back in 2018.”
Acker points to Sarepta Therapeutics (SRPT), which has a muscular dystrophy gene-therapy treatment, the first of its kind, scheduled for possible FDA approval this May. “[Muscular dystrophy] is a huge unmet medical need that affects children,” he says. “Patients typically end up in a wheelchair in their teens, and typically will die in their 20s.” Stock of the company is up 59% in the past 12 months, while SPDR S&P Biotech ETF is down 8%.
Yet Acker would be hesitant to pound the table for the entire sector: In biotech, “90% of the drugs that begin human clinical testing ultimately fail,” he says.
Biotech Boom and Bust
After two brutal years, small biotech stocks are due for a recovery
Skilled management and the wide dispersion in biotech stock returns is one reason that AlphaCentric LifeSci Healthcare (LYFIX) managed to lose only 0.8% in 2022 while the entire market collapsed. In 2023, the fund is up 13%. Manager Mark Charest has a doctorate in chemical biology from Harvard University and is a co-inventor on eight drug patents. His advisory firm, LifeSci Fund Management, is also a business affiliate of LifeSci Partners, a biotech/pharmaceutical consulting group.
A key driver of Charest’s outperformance is knowing which kinds of biotech companies large drug companies want to acquire. Though he doesn’t invest solely with mergers and acquisitions in mind, of “the last 30 M&A deals in biotech that were of a greater-than-$250 million takeout value, we’ve owned 16,” he says.
One company that Charest thinks has acquisition potential is BioCryst Pharmaceuticals (BCRX), which already has a drug approved for hereditary angioedema—a condition characterized by severe swelling. “[Biocryst] will do more than a quarter-billion dollars in revenue this year,” Charest says. He thinks the fact that the company already has a commercial product, and is still trading cheaply after last year’s selloff, could lead to an acquisition.
Other healthcare managers believe that acquisitions will continue to drive the performance of the best small biotech companies, as patents for many blockbuster drugs—such as AbbVie ’s (ABBV) anti-inflammatory treatment Humira and Merck ’s (MRK) top-selling cancer medicine Keytruda—are expiring soon. “We have massive patent-cliffs exposure across the pharma industry,” says Kyle Rasbach, a senior analyst at the Eventide Healthcare & Life Sciences fund (ETAHX). “So the need to acquire innovation is exceedingly high.”
Eventide mainly specializes in small biotech companies. But most active managers, like Acker, include in their portfolios other kinds of healthcare companies, such as insurers, medical-device makers, and hospitals.
There are advantages and drawbacks to both strategies. Well-diversified healthcare funds like Janus’, T. Rowe Price Health Sciences (PRHSX), and BlackRock Health Sciences Opportunities (SHSAX) held up better during the past two years of volatility than pure plays like Eventide, Fidelity Select Biotechnology (FBIOX), and Franklin Biotechnology Discovery (FBDIX).
Ziad Bakri, manager of the $15.4 billion T. Rowe Price Health Sciences fund, has about 30% of his portfolio in biotech, although more traditional pharma, a 16% weighting, overlaps with it. He thinks that biotech valuations are “reasonable” today and expects more M&A activity, but says there needs to be some “high-profile clinical trial and big commercial successes to lead to a real bull market.”
When that happens, the small-fry biotech funds will triumph again.