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Research team studying DNA mutations in lab.

Why we’re (still) positive on biotech

Contributor
  • Jordan Stuart

    Client Portfolio Manager

While its performance is currently on pause, this sector’s innovation is unstoppable.

During this period of market rotation, investors who have reaped years of rewards by investing in the high-growth biotech sector are currently feeling some pain. As long-time investors in this area, we believe it’s a good time to take perspective.

While biotech has some headwinds including the potential for more regulation, a steepening yield curve and volatility, our view as growth investors is that the long-term outlook for biotech remains strong. Here’s why:

Opportunity for differentiation Investors looking for differentiation beyond the broad market indexes favor promising biotech firms that typically are excluded from large index universes.

Accelerating innovation leading to robust product pipelines The link between computing power, genomic research and medical science is growing exponentially. Researchers can now apply powerful computing capacity to mine vast database networks that contain everything from an individual’s genetic blueprint and lifestyle information to the pharmacological properties of virtually every known compound to a store of information about previously used treatments. Biotech innovators can cross-reference this data in seconds, as they work to develop more targeted and effective therapies for cancer, diabetes, viruses and myriad diseases. The rapid and highly effective development of Covid-19 vaccines and therapeutics underscores these capabilities.

Abundant investment Year-to-date, more than 40% of initial public offerings were health-care-related with much of that investment going to biotech firms for building facilities, hiring scientists and funding research.

Food and Drug Administration is increasingly on board Clearly, the FDA’s complex approval process has the potential to present biotech firms—and their leading-edge therapies—with substantial obstacles. But facing pressure from patients, industry and Congress over the years, the agency has adopted a more innovation-friendly approach. The FDA continues to streamline its approval approach by applying the information they have gathered from one company’s trials to others wherever appropriate. Previously, each approval process existed as a separate silo, which was both inefficient and costly. The accelerating ability to collect, analyze and cross-reference enormous amounts of data from around the world is likely to support even more robust, timely and effective review of innovative therapies.

Historical outperformance DRG, the pharmaceutical index representing “big pharma” has outperformed the S&P 500 in only seven of the past 20 years.  Meanwhile, the biotech index—BTK—has outperformed the S&P 500 in 15 of past 20 years. 

More bark than bite from politicians Although investors may worry about Washington imposing price limits and other regulations on biotech firms, keep in mind the Democrats’ very narrow Senate majority. It would take just one “nay” vote from a big pharma/biotech state, such as New Jersey, New York, Massachusetts or California, to eliminate this sector overhang.

Amazing breakthroughs in biotech will increase, but when investing in such a complex, niche and less-covered area, two attributes are essential: patience and industry knowledge. Most drugs/treatments take 10 years to develop at an average cost of $2 billion. Plus, fewer than 12% of Phase I trial drugs receive FDA approval—despite an accelerated FDA approval process. When evaluating such an enormous array of potential opportunities, understanding the science, the industry, the key players and the competitive landscape is essential—as is being highly selective. Investing in biotech is nothing less than investing in the future of health care.

DISCLOSURES
Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Investing in IPOs involves special risks such as limited liquidity and increased volatility.

Past performance is no guarantee of future results.

Growth stocks are typically more volatile than value stocks.

Stocks are subject to risks and fluctuate in value.

DRG: The NYSE Arca Pharmaceutical Index (DRG) is a capitalization-weighted index designed to represent a cross section of widely held, highly capitalized companies involved in various phases of the development, production and marketing of pharmaceuticals.

BTK: The NYSE Arca Biotechnology Index (BTK) is an equal dollar weighted index comprising a cross section of companies involved with nanotechnology, genetics, molecular biology and other products and services in biotechnology.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Federated Advisory Services Company