Defence strategy

When there are concerns about broad economic slowdowns, as there are in the US and have been in Europe, investors’ attentions tend to veer away from economically-cyclical sectors, and towards defensive asset classes. In equities, this has traditionally been healthcare and pharmaceuticals. The recent wave of acquisitions of biotechnology companies by pharmaceutical companies reveals fundamental dependencies between these sectors and the realisation that, in combining growth and defensive characteristics, biotechnology may be the new pharmaceuticals. But there are great dangers in assuming that biotechnology companies are the same both inside and outside the US. In effect, biotechnology is not so global.

Indices that track the US biotechnology sector are trading at 52-week lows after a very volatile year. While the current lows reflect investors’ concerns on a large number of drugs that did not obtain either marketing approval or positive clinical trial results in the last year, they are currently discounting the wave of merger and acquisition activity sweeping the biotechnology sector. The pharmaceutical sector has been active of late, showing aspirations to license or acquire pipelines from the biotechnology sector.

While the US biotechnology sector currently represents good value, what of markets closer to home? The UK is perhaps the second oldest biotechnology hub and in the last year the few indices that track it have done well compared to those in the US.

The acquisitions of Cambridge Antibody Technology and NeuTec Pharma by AstraZeneca and Novartis respectively reflect this. Some observers worry about the remaining biotechnology universe and cite the concern that the sector has ‘hollowed out’. There are still a few good biotechnology and medical device companies listed in the UK but these remain the exception rather than the rule and we are invested in them. There are also a number of good private UK biotechnology investments, but most investors have not heard of them. These include PowderMed which has just been acquired by Pfizer. Pfizer bypassed the also-rans left on the main market in London and went straight for a later stage VC-backed company that may have thought about a London list in a year or two.

London’s AIM is one stock exchange listing the complete range of global companies but, with a few exceptions, it remains the exchange of choice where biotechnology companies can list and access a diverse set of investors. In general the AIM market does not allow biotechnology companies to raise the significant amounts of cash required to fully develop their technologies so they tend to be disadvantaged compared to their better-funded US competitors. There seems to be a lack of correlation with the continuing strong performance of UK biotechnology and the fundamental basis of most of the sector in the UK.

Two of the pillars of the now often derided efficient market theory (EMT) are that investors act rationally and independently of each other. While writers on behavioural finance now tell us that these two pillars of the EMT are flawed, they do not tell us why. In specialist sectors, I believe the reason is obvious: Both professional and retail generalist investors turn to analysts that are, in many cases, not as experienced in the pharmaceutical and biotechnology sectors as they are in more general sectors. As such they are less able to give the same depth of insight. In the short-term this points to sophisticated investors with a global perspective focusing on the US. In the medium term, however, investors in the majority of UK biotech-nology companies may only have the usual regulatory and clinical trial failures to look forward to as the market for these companies matures.

Andy Smith is manager of the International Biotechnology Trust