Hedge funds are hunting for bargains in the beaten-down biotechnology sector, betting that a vicious sell-off has run its course and that lower valuations will breathe life back into deal flow.
A Nasdaq index of biotech stocks has tumbled almost a third from its all-time high last August, as hopes about the Covid-19 pandemic boosting the industry gave way to worries about frothy share prices. The sharp sell-off has, in turn, left many companies struggling to raise new funding.
However, some hedge fund managers now believe that prices have fallen too far relative to firms’ drug development prospects and their remaining cash levels. Those investors have started buying up stocks on the cheap, or launching portfolios to capitalise on the turmoil.
“This is the worst correction [in the biotech sector] I have seen in my 22-year career”, said Michele Gesualdi, founder of London-based investment group Infinity Investment Partners. “We have never seen stress like this.”
Gesualdi’s firm, which manages $1.5bn in assets, recently launched a new fund specifically to focus on opportunities in the life sciences sector. He added that the sector is, on all metrics, “as cheap as it has ever been”.
Industry insiders attributed the sell-off in the sector in part to the departure of so-called tourist investors who do not specialise in biotech but who were hunting for returns during the early stages of the pandemic. Investors have also grown concerned about regulatory scrutiny of dealmaking and the possibility that companies may start to run out of funding.
The ensuing market reversal has proved particularly difficult for a sector that had grown accustomed to record-low interest rates and a seemingly never-ending equity bull market. Such companies’ future profits are highly valued when interest rates are near zero, but appear less so when borrowing costs rise.
“Coming out of the Covid tunnel, seeing inflation rise at [a] higher pace than predicted by any central bank, the [biotech] sector has faced unexpected adversity,” said Philippe Wolgen, chief executive of Australian biotech Clinuvel Pharmaceuticals, whose share price has fallen from almost A$45 in September to A$15 (US$10).
After a “catastrophic” fall in the sector, fund managers and bankers “are openly expressing their aversion to perpetuating these risky ventures”, he added, referring to backing companies with little prospect of revenues in the near term. However, he said investors were starting to look at “genuine business[es]” in the sector.
Mergers and acquisitions activity, meanwhile, traditionally a major support for valuations as big pharmaceutical companies look for ways of building their drugs pipeline, has also dried up. The deal count in 2022 has fallen to its lowest level for the opening six months of a year in more than a decade, according to Evaluate Pharma.
The sell-off has hit some specialist healthcare hedge funds hard. One of the highest-profile funds to suffer is New York-based Perceptive Advisors, which lost about 32 per cent last year and is down 35 per cent this year to late June, according to numbers sent to investors and a person familiar with the performance.
California-based Endurant Capital, run by Vietnamese trader Quang Pham, lost 6.8 per cent in its Health Master fund this year to the end of May, although it has made back some ground in June. Last year San Francisco-based Asymmetry Capital shut after losses, with its founder highlighting how difficult life had become for small, biotech-focused funds.
Nevertheless, some managers believe now is the right time to build exposure to the sector.
“It’s the one area where there’s been complete and utter capitulation,” said Andrew Clifford, chief executive of Sydney-based Platinum Asset Management, which manages $14bn in assets. The firm is launching an EU-regulated version of a health sciences fund it already manages, as it tries to profit from the sell-off.
SYZ Capital has also been adding to its positions in funds trading the sector, and sees opportunities in the US and, longer term, in China. “We are positive on biotech”, said Cedric Vuignier, head of liquid alternative managed funds.
UBS’s hedge fund unit O’Connor earlier this year hired a team from Alera Partners to run a new strategy betting on rising and falling prices and focused on healthcare therapeutics. The strategy is part of O’Connor’s multi-strategy fund, but could eventually be launched as a separate fund, said a person familiar with the firm’s plans.
“Healthcare is a perfect example of where we want to be exposed,” said chief investment officer Kevin Russell, who believes there is capacity for more than $1tn of deals in the sector as pharma companies try to build their drug pipeline.
Russell added that there had been “very little distinguishing between stocks” by investors.
“We think [this] is a function of a lack of experience and scientific knowledge” among investors, and should present opportunities for O’Connor to make money betting on rising and falling prices, he said.