The political news flow on drug prices started in 2014 (in fact, those discussions have been around since the 1990’s) and the sector had resisted well until end of 2015.
It is odd that this correction happens at a time when innovation is really at its best. The sector enjoyed a huge performance over the years but has often also undergone severe corrections (this is why we position this as a satellite strategy) but each time it emerged strongly from those corrections. In this environment of indiscriminate selling, it is almost impossible to stay out of the rain and to differentiate meaningfully. We refrain from putting meaningful money into those pharmaceutical companies that have a major biotechnology component like Roche or Bristol Meyers, as we find the valuation of many smaller and mid cap biotechnology names extremely low and hence it seems too late, at least on any longer term view, to make the fund ultra-defensive. We have a higher weighting now than before in the mega-cap biotechnology names like Celgene and Biogen, as those stocks as a group are holding up much better. And the FDA is very constructive, with 45 approvals of drugs (many of them biotechnology drugs) during 2015. Earnings are great and pipelines are full, in fact there is so much innovation that even specialist investors are having trouble identifying the next winners amongst all those interesting drugs. Valuations are very interesting, with the mega-cap biotechnology P/E’s well below the P/E of the S&P500 now, something almost unheard of in the history of the sector. We think the sector will recover but this recovery will be volatile and any timing is difficult to forecast. After all, drug prices are only 10-15% of all health care spending and many drugs keep people out of hospital for some time and hence help the system save money. Do we really want the emerging immune-oncology miracle to stop now that it starts delivering? Will we tell the 70 year old patient who loses his eyesight due to macular degeneration that we cannot do anything for him despite good pipelines? Sensible discussions on drug pricing are needed, not harsh rhetoric. No politician, whatever his allegiance, wants to stop the on-going amazing innovation. We think that in the end drug prices will remain at levels where investors can make a decent return on the risks they have been taking while funding biotechnology research. In all fairness, it has been “open bar” in terms of drug prices for many years hence some reasonable push back is even to be applauded from an ethical stand point. We see the sell off as hugely exaggerated with the caveat that the political comments on drug pricing will persist for some time but this is to be expected. Some green shoots in terms of commodity/energy sector performance started a tentative sector rotation into selected value sectors and names, again compounding the problem. The very mediatized and polarizing US presidential election campaign with numerous attacks on the level of drug prices in the US acted as the trigger while general liquidity in equity markets (or rather, the lack of it) exaggerated the move.
Investor positioning is somewhat to blame as, at least in the US, investors were rather well invested in biotechnology.
The biotechnology sector has undergone a very hefty correction from the start of 2016.
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