Biotechnology is the realm, on one hand, of marvellous cures and hockey-stick earnings curves; on the other, of bankruptcies by the dozens.
“I always get nervous when I talk about these companies,” says Martin Hubbes, co-manager of AGF Funds Inc. ’s $21.9-million AGF Global Health Sciences Class in Toronto. “It’s great fun, this is science moving forward and you’re investing in changing people’s lives. But this is definitely not a solution for your whole portfolio.”
The odds of success for a random biotech company are narrow, say fund managers such as Hubbes. In the global biotech universe, about 1,100 products are in various phases of clinical trials. About one product out of 100 makes it from Phase I to Phase III clinical trials.
Nevertheless, there are a few winners. And when they succeed, they succeed big. One example is Summit, N.J.-based Celgene Corp., in which the AGF fund maintains a 5% holding.
Celgene is focused on anti–tumour agents for myeloma, a blood cancer. One of its drugs, Thalomid, is already on the market, and another, Revlimid, which is a derivative drug with increased potency, has just come out.
“Thalomid was an example of a late-stage drug in which we thought we could have some sort of insight into its clinical trials,” Hubbes recalls. Thalomid offered a “sneak peak” at the potential for Revlimid, he says.
The AGF fund bought Celgene at an equivalent of about US$16.50 a share (it has gone through a few stock splits since); it now trades at about US$53 a share.
Because of the risk, most advisors tend to steer investors toward a more broadly based health-care fund in which biotech might make up 5%-10% of the portfolio. Investing in a specialty health-care sector is already a narrow mandate.
“To take that other step and have a narrow mandate in biotech is not suitable for the vast majority of investors,” says Dan Hallett, president of Windsor, Ont.-based fund analyst Dan Hallett & Associates Inc.
Advisors considering biotech will find a range of options for their clients, starting with broadly based global health-care funds with the mandate to invest between 10%-20% of their portfolios in the biotech industry. Pure biotech mutual funds are available, but the greatest choice is in the exchange-traded funds realm. For the most risk-tolerant, advisors can suggest investing in venture capital and labour-sponsored investment funds that invest heavily in the field.
Advisors will find that global health-care funds such as AGF’s are the most common way to get biotech exposure. Like many broadly based global health-care funds, it maintains a relatively small direct exposure (13%) to the biotech sector, with slightly more through large pharmaceutical companies such as GlaxoSmithKline PLC or Wyeth that either develop biotech drugs or license them from the upstarts.
The AGF fund invests mostly in later-stage companies with drugs that are nearing approval from the U.S. Food and Drug Administration, says Hubbes: “We have some early-stage companies, but we’ve tried to focus on near-term opportunities because we want to keep the fund relatively conservative.”
As the drugs “start commercializing, we trim our holdings because the market gets a little overexcited at the prospects of most drugs,” says Hubbes. “If sales rise, we’ll stay invested; if not, we’ll move to something else.”
In that vein, Vancouver-based Cardiome Pharma Corp. , a 2.2% holding for Hubbes, is on the verge of approving Vernakalant, an intravenous drug therapy that relieves severe conditions of atrial arrhythmia (irregular heartbeat). Less certain of approval is an oral version of the drug in Phase II clinical trials that could be widely used — a so-called “blockbuster” drug — and potentially very profitable for the company. (See story on page 42.)
The same promise applies to Montreal-based MethylGene Inc. , a much smaller holding, which floated about $20 million in equity through Cannacord Capital Corp. in early February. It’s another long shot with several drugs in early trials, including one drug aimed at cancer treatment.
Many biotech companies are invested in exploring enzyme-based drugs for suppressing tumour growth. “It’s very early days. The area is interesting,” says Hubbes, who adds that 99% of companies that fail. MethylGene has “a good seat at the table, but you never know.”
“The companies I have large exposure to are diversified health-care companies, and other positions are pretty small because they hold a lot risk even though they have home-run potential,” says Evan McCulloch, a biotech analyst and manager of Toronto-based Franklin Templeton Investments Corp. ’s $13.3-million Franklin World Health Science and Biotech Fund. (See chart, above right.)
@page_break@The fund holds many large-cap health stocks, including some major pharmaceuticals. Outside the top 10, it holds a relatively small, 1.54% weighting in Celgene, plus a variety of holdings at 1.5% or less in companies such as Genzyme Corp., Indevus Pharmaceuticals Inc. and Digene Corp.
Investing in handfuls of hopefuls is less risky because mergers and acquisitions among them are a possibility. Fund managers note that small biotech firms occasionally merge with others and, more often, larger pharmaceutical companies swoop in to make a deal.
“Pharmaceutical companies have finally admitted their pipelines are weak and they’re buying,” says McCulloch.
Pfizer Inc., Johnson & Johnson and Merck & Co. Inc. , among others, will see patents expire on profitable drugs, and have all hedged their bets with partnerships of various depths with biotech companies. They either fund research in exchange for preferential — but only potential — licensing deals, or buy companies outright.
Roche Holding Ltd. of Switzer-land, for example, first took a position in Genentech Inc. , bought it outright, then spun it out again as a stand-alone company in which Roche still has a substantial holding, explains McCulloch. Genentech manufactures Herceptin, a drug that blocks tumour growth in breast cancer patients, among many other oncological drugs.
More risk-tolerant investors have other options. Toronto-based Altamira Investment Services Inc. ’s Altamira Biotechnology Fund and Toronto-based CI Investments Inc. ’s Global Biotechnology Corporate Class are two pure biotech funds, but performance has been volatile and slightly negative since their inception dates in 2000 and 1999, respectively.
Several pure biotech ETFs, such as Merrill Lynch & Co. Inc. ’s HOLDRs Biotech Fund, are available on U.S. exchanges. They feature much lower management expense ratios — actively managed funds range upward from 2.5% — but they share in the volatility.
No matter where drugs are in the testing phases, mutual fund managers tend to lean on the same general investing criterion.
They preach the mantra of patience, even more than usual, because they invest for the long run. “Drug development is a long, drawn-out, meticulous process, as it should be,” says Hubbes. “When I buy these, I expect to make money in the next five to 10 years.”
Fund managers also cite “strong management” at the companies among their criteria. Company management, hopefully, has sound scientific knowledge, as well as an understanding of the hurly-burly of fundraising and deal-making.
Fund managers often say they invest in companies looking to fulfil “large, unmet needs” — meaning companies that design drugs for large populations with medical conditions that don’t already have access to effective drugs, such as people suffering from cancer, HIV, diabetes or heart disease.
Managers also want to back companies that are already well funded so they will be able to complete their drug trials. Finally, fund managers look for biotech firms with high-potential intellectual property — meaning: more than one drug in the works.
VENTURE CAPITAL AND LSIFS
At the extreme end of the risk spectrum are Canadian venture-capital funds and limited partnerships that invest solely in biotech. LSIFs have mandates to finance Canada’s early-stage efforts in the field, too.
“Some investors may consider my fund, from a Canadian landscape, to get exposure to an asset class that they otherwise cannot get,” says Dr. Luc Marengère, managing general partner and fund management leader at VenGrowth Private Equity Partners Inc. in Toronto.
The $233-million VenGrowth Advanced Life Sciences Fund, the largest life sciences fund in the country, is probably the purest Canadian biotech fund you’ll find, with more than 65% of its portfolio invested in biotech.
That the fund has lost only 2% in the four years since its inception, says Marengère, “is in itself solid.” Funds often lose 20%-40%, he adds. VenGrowth’s strategy is to invest in drugs that are in clinical trials, with an eye to exit within four to six years.
Marengère describes the fund’s management team as a “financing consolidator” that will look for partners to carry drugs through trials. The fund’s investment in Cita NeuroPharmaceuticals Inc. , for example, saw the biotech firm partner with private Italian company Chiesi Farmaceutici SpA to carry forward an Alzheimer’s disease treatment. Chiesi was pleased with the results and, in turn, gave VenGrowth an option on a Parkinson’s disease–related drug that ultimately was sold to Vernalis PLC in 2005.
Today, Marengère says, Montreal-basedTarganta Therapeutics Inc. , which develops anti-bacterial drugs, is poised for an initial public offering in 2007. In early February, it received $70 million in financing from various investors to complete the clinical trials for Oritavancin, a treatment for skin infections. “If it’s successful as an IPO or a private sale, we’ll have a compound rate of return of more than 30%,” he says.
The payoff for an investment in an early-stage biotech company can be remarkable.
For example, Growthworks Working Opportunity Fund, managed by Growthworks Capital Ltd., of Vancouver, invested in Angiotech Pharmaceutical Inc. , before it grew into a broadly based pharmaceutical and biotech firm.
Pat Brady, vice president of investments at the Vancouver-based Growthworks LSIF, says the risk has paid off in more than 50% returns. Today, the fund, with about a 35% exposure to life sciences, is taking a similar bet with Vancouver-based OncoGenex Technologies Inc. , another biotech firm developing a drug that promises to reduce a tumour’s resistance to chemotherapy.
Canadian life sciences investments have regained some luster over the past year, rising to about 25% of all venture-capital inflows, up from 15% three or four years ago, says Brady. “That’s reflective of performance in the biotech field,” he says.
The $100-million CTI Life Sciences Fund LP is a newcomer as of last autumn. With seed capital from Montreal-based FIER Partners LP and Caisse de dépôt et placement du Québec, among others, the fund aims to invest in early-stage biotech drug and medical-device developers.
Richard Meadows, a general partner at CTI, says the fund ideally exits from its investments during Phase I or Phase II drug or device trials, when big pharmaceutical companies are likely to take their investment positions.
Investors interested in joining the CTI LP need $1 million in capital and a business plan demonstrating their commitment to the project. IE
Roll back the risk of investing in biotechnology
Pure biotech investments may not be the solution, so some managers steer investors toward broader health-care funds
- By: Gavin Adamson
- March 5, 2007 March 5, 2007
- 14:27