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Biotech Returns - 30 Years of Disappointment - TEBI
Biotech Returns - 30 Years of Disappointment - TEBI
The biotechnology sector was billed as the next big thing in the early 1990s, and it remains one of the most popular investment
“themes” today. Although the potential for growth is indisputable, returns have so far been unimpressive, and the sector still
accounts for just 4% of the Nasdaq Composite Index. Also, as NICOLAS RABENER explains, active fund managers specialising in
biotech have failed to generate alpha.
Introduction
Most technological change today is an evolution rather than a revolution. Naturally, it is great to have a mobile device that allows instant
access to the global knowledge depository, entertainment, shopping, and so on, but most of these innovations have been predicted decades
ago by science fiction authors. Reading such novels actually makes human progress seem awfully slow. Human colonies amongst the stars
and interstellar travel still seem ages away.
Aside from building better machines to help us in work and life, changes to our bodies and genes are also frequent topics of science fiction.
The progress there seems even slower.
Although the life science industry did manage to create COVID-19 vaccines in a short time period, we still suffer from cancer, tooth decay,
and obesity. It is obvious that most of such conditions can be fixed with genetic modifications at some point.
Investors focused on long-term themes often include an allocation to this genetic revolution. There are plenty of broad indices that provide
exposure to biotechnology or pharmaceutical stocks, as well as strategies specialised in cancer, gene editing, and Chinese biotechs.
In this research article, we will evaluate the track record of the biotech sector in the US stock market.
Source: FactorResearch
If we measure the alpha generated over the last decade by hedge fund managers, then this is negative as the index underperformed the
Nasdaq Biotech Index significantly since 2012.
Naturally, hedge fund managers might argue that they provide more than long-only exposure, but that is not true in the case of these
biotech hedge fund managers. Their performance shows the exact same trends as the Nasdaq Biotech Index, which highlights little to zero
short positions, and can be replicated easily through a simple combination of equity exposure via an ETF and cash.
Further thoughts
Biotechnology will have an increasingly larger impact on our lives as innovations incur, which can range from stopping or reversing hair loss
to extending our natural life spans to centuries. The potential is there and has always been, but it has not been a great bet for investors so
far.
It is interesting to consider why active management has not created value in this sector. Many mutual and hedge fund managers have
outside advisors that are experts in drug development, for whose advice they pay thousands of dollars. This should create a competitive
advantage compared to a generalist portfolio manager or retail investors, but it has not. Financial experts are overrated given the general
lack of alpha generation by active managers, but it seems scientific experts fare no better.
NICOLAS RABENER is the managing director of FactorResearch, which provides quantitative solutions
for factor investing.
Robin writes:
Intuitively, you’d think that an easy way to make money in stocks would be to identify, in advance, a sector that’s going to grow massively
and invest heavily in it.
Unfortunately it’s not that simple. People who invested in railway stocks in Britain and Ireland in the 1840s, for example, or in dotcom stocks
in the 1990s, were on one level absolutely right: both were game-changing technologies which went on to have a huge impact on people’s
lives.
But making money from that accurate prediction was altogether more challenging. Most of the benefits of rail travel and the internet accrued
not to shareholders but to consumers. Indeed, the vast majority of companies went bust. Of course, it was possible in theory to pick one of
the very few long-term survivors ex ante, but the odds were very heavily stacked against you.
So although Nicolas Rabener’s findings on biotech stocks might seem surprising, they are actually anything but.
As Nicolas rightly says, biotechnology has the potential to help us live longer, healthier lives, and it’s fair to assume that, one day, biotech
stocks will account for a much larger share of the stock market than they do today. But knowing when to invest, and which stocks to invest
in, is extremely difficult; specialist professionals have mostly failed to beat the market.
A far more sensible strategy is to diversify across every sector, paying particular attention to factors such as size and value which have
historically produced higher returns.
Biotechnology may well have a very positive influence on your life and mine in the years ahead; but it’s unlikely to make either of us
spectacularly wealthy.
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