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How to Be Discerning With Biotech Investments

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It pays to be discerning in financial markets. The action in biotechnology stocks this year is a reminder of the benefits of that advice. For example, the large-cap Nasdaq Biotechnology Index is up just 0.53% (as of May 24th).

The top four components in the Nasdaq Biotechnology Index are all large-cap stocks, but just one; Amgen Inc. (AMGN), is higher on a year-to-date basis. Celgene Corp. (CELG), another marquee member of the Nasdaq Biotechnology Index, is down 23.16% as of May 24th.

Through about five months of 2018, one thing is clear in the healthcare sector, including biotechnology investments: smaller has been better. Consider this: As of May 24th, the Russell 2000 Index and the S&P SmallCap 600 Index are up 6.28% and 7.55%, respectively, year-to-date. The S&P 500 is up just 2.24%. On May 23rd, the Russell 2000’s healthcare weight was nearly 200 basis points higher than the S&P 500’s. As the chart below indicates, smaller healthcare companies, including biotech names, are playing a pivotal role in the recent resurgence of broader small-cap benchmarks.

On The Prowl

Since the start of 2018, a widely cited catalyst for mid- and small-cap biotechnology companies has been speculation that industry consolidation is poised to increase. While mergers and acquisitions (M&A) activity has been brisk since the start of the year, the largest biotech and healthcare companies still have plenty of room to make deals.

Leerink analyst Geoffrey Porges notes the 20 largest biopharma companies have a combined worth of about $3 trillion with just $186 billion in combined debt, according to Barron’s.1 There are no shortage of candidates in the mid- and small-cap biotech spaces that could be evaluated for takeovers by larger competitors.

BeiGene, Ltd. (BGNE), a clinical-stage, research-based biotechnology company focused on molecularly targeted and immuno-oncology cancer therapeutics, has seen its shares climb more than 420% over the past 12 months, but the company’s market value is an approachable $10 billion.

In April, the company said “that the first patient was dosed in a global Phase 2 clinical trial of tislelizumab, an investigational anti-PD-1 antibody, in patients with relapsed or refractory mature T- and natural killer (NK)-cell lymphomas.”2

Last year, Celgene and BeiGene entered into partnership with Celgene to develop BeiGene’s cell death protein 1 (PD-1) inhibitor, BGB-A317, for patients with solid tumor cancers for patients in the U.S., Europe and Japan, among other markets.

GW Pharmaceuticals (GWPH) is another example of the potential potency of mid- or small-sized biotechs. The shares are up 51.57% over the past 12 months. Recently, the stock climbed after the Food & Drug Administration (FDA) recommend approval for GW’s lead product, Epidiolex, an oral treatment for refractory childhood epilepsies, as well as for the treatment of Dravet syndrome and Lennox-Gastaut syndrome.

The drug’s active ingredient is cannabidiol (CBD), which is derived from cannabis plants, but does not contain the properties that make marijuana users high.

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A Basket Approach

The ALPS Medical Breakthroughs ETF (SBIO), which tracks the Poliwogg Medical Breakthroughs Index, only features companies with market values of $200 million to $5 billion (at the time of rebalancing). SBIO provides investors with a broad-based basket of mid- and small-cap biotech names, some of which could be takeover targets and many of which are working potentially blockbuster drugs and treatments.

Additionally, the Poliwogg Medical Breakthroughs Index requires member firms to have enough cash to survive at least 24 months at current burn rates. Through May 24th, the Poliwogg Medical Breakthroughs Index was up 12.59% year-to-date.

*Celgene Corp (CELG) was not held in the SBIO fund as of 5/24/18
*Beigene LTD-ADR (BGNE) was a 5.49% holding in SBIO as of 5/24/18
*GW Pharmaceuticals Inc (GWPH) was a 2.85% holding in SBIO as of 5/24/18
1 Source: Barron’s May 24, 2018 https://www.barrons.com/articles/biopharma-m-a-you-aint-seen-nothing-yet-1527171870?mod=hp_SF
2 Source: BeiGene statement April 16, 2018 https://finance.yahoo.com/news/beigene-initiates-global-phase-2-110000254.html
Important Disclosure & Definitions
This material must be preceded or accompanied by a prospectus. Please read it carefully before investing
Standardized performance for the ALPS Medical Breakthroughs ETF (SBIO) can be found here. Current holdings for SBIO can be found here
Shares are not individually redeemable and the owners of shares may purchase or redeem shares from a fund in creation units (blocks of 50,000 shares) only.
This fund may not be suitable for all investors. There are risks involved with investing in ETFs including the loss of money. The Fund is considered non-diversified and as a result may experience great volatility than a diversified fund. The Fund’s investments are concentrated in the pharmaceuticals and biotechnology industries, and underperformance in these areas will result in underperformance in the Fund. Investments in small and micro capitalization companies are more volatile than companies with larger market capitalizations.
Companies in the pharmaceuticals and biotechnology industry may be subject to extensive litigation based on product liability and similar claims. Legislation introduced or considered by certain governments on such industries or on the healthcare sector cannot be predicted.
Companies in the pharmaceuticals industry are subject to competitive forces that may make it difficult to raise prices and, in fact, may result in price discounting. The profitability of some companies in the pharmaceuticals industry may be dependent on a relatively limited number of products. In addition, their products can become obsolete due to industry innovation, changes in technologies or other market developments. Many new products in the pharmaceuticals industry are subject to government approvals, regulation and reimbursement rates. The process of obtaining government approvals may be long and costly. Many companies in the pharmaceuticals industry are heavily dependent on patents and intellectual property rights. The loss or impairment of these rights may adversely affect the profitability of these companies.
The development of new drugs generally has a high failure rate, and such failures may negatively impact the stock price of the company developing the failed drug. Biotechnology companies may have persistent losses during a new product’s transition from development to production. In order to fund operations, biotechnology companies may require financing from the capital markets, which may not always be available on satisfactory terms or at all.
Cash burn: Burn rate is normally used to describe the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations; it is a measure of negative cash flow. Burn rate is usually quoted in terms of cash spent per month.
The author is not an investment professional and this article should not be considered investment advice. While the information and statistical data contained herein are based on sources believed to be reliable, the author takes no responsibility to ensure the accuracy of the content. Additionally, this article should not be relied on or be the basis for an investment decision. Information that is historical is not indicative of future results, and subject to change.
ALPS Advisors, Inc. (AAI) has engaged IRIS Werks, LLC (IRIS) to produce analysis and commentary on ALPS-advised ETFs. IRIS currently has a compensated business relationship with AAI. AAI is not affiliated with IRIS.
The content and opinions expressed in this article are that of the author and not the views and opinions of ALPS Advisors, Inc. In addition, ALPS Advisors, Inc. assumes no responsibility to ensure the accuracy of the content written by the author.
Poliwogg Medical Breakthroughs Index – The Poliwogg Medical Breakthroughs Index is designed to capture research and development opportunities in the pharmaceutical industry. PMBI consists of small and mid-cap pharmaceutical and biotechnology stocks listed on US
Nasdaq Biotechnology Index – Modified market capitalization-weighted index designed to measure the performance of all Nasdaq stocks in the biotechnology sector.
S&P SmallCap 600 Index – The Standard & Poor’s Smallcap 600 Index is a capitalization-weighted index that measures the performance of selected U.S. stocks with a small market capitalization.
Russell 2000 Index – Is comprised of the smallest 2000 companies in the Russell 3000 index, representing approximately 8% of the Russell 3000 total market capitalization.
One may not invest directly in an index.
ALPS Portfolio Solutions Distributor, Inc. is the distributor for the ALPS Medical Breakthroughs ETF
SMB000210 12/31/18
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