Now is the time to get into biotech stocks, whose prospects are bright amid a surge in innovation and a more lenient regulatory climate, according to Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management.
“We believe that the post-pandemic era may be a golden age for private investment in life sciences,” wrote Gross in an analysis. While biotech (public market cap: $577 billion) remains a capital-intensive undertaking with more failures than successes, the promise has never been greater, he contended.
Gross’ analysis comes at a time when biotech’s share prices are low: The SPDR Biotech exchange-traded fund is up just 1.6% this year, as of Friday, compared with the overall S&P 500, which is ahead 9.5%. Meanwhile, publicly traded biotech firms’ revenue grew 23% in the past year, although high costs have helped drag down earnings.
Part of the problem is that deal activity—small biotech outfits often rely on getting acquired by Big Pharma—for all industries was down 21% in the year’s first quarter, amid rising interest rates and economic uncertainty.
Consequently, many “institutions are under-allocated to life science,” Gross wrote in the report, co-authored by Carter Massengill, a JPM associate for institutional asset management. Indeed, in 2022, direct investments (that is, investing without buying any publicly listed securities) in biotech and pharma were cut in half from the prior year by sovereign wealth funds and public pensions, to around $80 billion and $50 billion, respectively.
For sure. the cost of biotech innovation is enormous, dwarfing developmental outlays for information technology, Gross observed. “Nobody will be developing the next cancer cure in a dorm room or garage,” he quipped. Software and hardware companies use “common electronic components.” But, he added, “biomedical research requires access to costly scientific instruments and laboratory facilities.”
Another hurdle for biotech that IT does not face is the strict federal regulatory approval the creators of new drugs and other medical innovations must seek and receive. The U.S. Food and Drug Administration has long made life sciences innovators run a costly and multi-step gauntlet. As Gross pointed out, “regulatory approval process can wipe out a firm’s prospects overnight, with little opportunity for the team to go back to the drawing board.”
Certainly, the lifeblood for startups—venture capital—whether for biotech or not, is replete with failures. “This dynamic is often referred to as the ‘power law’ in venture capital,” Gross wrote. “A fraction of all investments can drive significantly positive returns for an entire portfolio.” This situation has favored giant pharma companies to make breakthroughs, either themselves or via acquisitions.
That dynamic, however, is changing, Gross argued. New factors are giving advantages to the smaller players, allowing them to achieve new discoveries on their own, he said: higher Washington funding for early-stage firms; quicker regulatory review spurred by the need for new vaccines and treatments to combat COVID-19; and advances in artificial intelligence.
The higher federal funding trend actually began before the pandemic, Gross noted. Over the past decade, research funding from the National Institutes of Health expanded 131%, hitting $292 billion in 2022.
The upshot is that the number of new drugs approved by the FDA annually has nearly doubled over the past five years, compared with the historical average. If so, both investors and patients will benefit.