Biotech has been a major growth sector over the past decade and now, in light of the COVID-19 pandemic, biotech has taken center stage like never before. According to Jack Plotkin, Investment Banking Strategist who spent nearly a decade at Goldman Sachs, investing in the biotech sector comes with risks, but, if properly understood, can also yield tremendous gains.
The biotech industry is broad and, like its name suggests, combines concepts and approaches from both biology and technology. The equity chart for any major U.S. biotech index tells the story of massive growth. However, Plotkin notes, that indices do not tell the whole story.
“The biotech landscape is littered with dead companies and destroyed capital,” says Plotkin. “The majority of biotech startups never make it. If they get past R&D, they get blown up in clinical, or fail get the green light from the FDA.”
Every potential product in a biotech company’s pipeline must pass four complex and capital-intensive stages before being approved: discovery and development, preclinical research, clinical research and FDA (Food and Drug Administration) drug review. Clinical-stage research – conducted in humans – is made up of three demanding stages before the drug can go into the FDA review process. It is estimated that only 6% of products that make it to clinical-stage research make it all the way through FDA review.
Plotkin highlights that there are multiple ways to invest in biotech, including buying shares of publicly traded biotech companies, investing in biotech exchange-traded funds (ETFs), and placing capital with private companies or biotech-focused venture capital and private equity firms. Between 2013 and 2019, the value of biotech deals that venture funds closed increased threefold. Recently, there has also been an increase in the number of “crossover” investors who are investing in both private and public companies. These investors often come at a later stage and provide help to companies during their critical pre-IPO period.
“Most investors looking to gain biotech exposure should focus on ETFs and established leaders in the space,” advises Plotkin. “The sector requires both patience and resilience. It often takes a decade and a billion dollars to shepherd a drug to the market. Given all the downside scenarios, diversification is key.”
Buying an ETF provides an investor with exposure to the various biotech companies in the ETF’s portfolio while investing in a large biotech company provides an investor with exposure to all the products and R&D efforts in that company’s pipeline. Both are examples of diversification. By contrast, investing in a biotech that only has a single major drug in its pipeline can erase the entire investment if that company fails to bring that drug to market.
“Before investing in a specific biotech company, be sure to understand that company’s pipeline,” says the former Goldman Sachs strategist. “Not just the compounds, competitors, and addressable market, but also the development stage. Molecules that are still in R&D should be massively discounted from a cashflow perspective – odds are they never make it to market.”
Biotech and COVID-19
The COVID-19 pandemic offers massive upsides to companies who can develop a working vaccine. One such company is Cambridge-based Moderna, which has received a lot of public attention and seen its stock price skyrocket since March. However, Plotkin points out that many other biotech companies and projects with a non-COVID focus have experienced considerable delays in clinical trials as a result of the resource diversion toward COVID-related efforts. The result is likely to be a slowdown in the biotech sector overall in the coming 12 to 18 months.
Despite the risks, Plotkin highlights that investor interest in the biotech sector shows no signs of abating. Biotech indices have shrugged off March losses and are in the black for the year. The iShares NASDAQ biotech Index (IBB) has been outperforming the S&P 500 for the last 12 months (29.9% to 19.1%). The capital and research driving biotech are at a peak.
“No question about it, biotech is the future,” says Plotkin. “The gains are going to be there, but unlike buy-and-hold dividend-paying industries, effective investing in biotech requires due diligence. The investors who put in the time to learn the players, the pipelines and the progress will be the long-term winners.”
See more from Jack Plotkin.