History Rhyming

Apr 15, 2022

Investment markets are interesting organisms. The way that they fluctuate, and the reasons they do, owes a great deal to the saying, usually attributed to Mark Twain:

History doesn’t repeat itself, but it often rhymes.

That this is so is because of the largely predictable collective psyche and behaviour of the humans who run markets. It is said that the ultimate dream of a trader is to be able to deal in the market today using tomorrow’s prices. Sadly, you can never do that, so investing always requires a ‘leap of faith’. If that leap is into the arms of a Fund Manager, you need to make sure they are trustworthy and competent.

Now to history rhyming, group behaviour, and the current state of the listed global biotech markets.

We launched our HB Biotechnology IMA offering in early 2021. It had a notional minimum investment of $1m per account for parties not known to the firm or its principals, and $500k for those known to the firm or existing clients. In April this year we launched a complementary Biotech Investment Trust with a minimum subscription of $250k.

Since inception our portfolios in aggregate have substantially outperformed the relevant benchmark. Pleasingly, as of 30 April 2022, every single client’s portfolio has outperformed its benchmark index both before and after fees.

Alas, the outperformance has been against a backdrop of a savage fall in the prices (not the long term value, in our view) of stocks generally in this sector, particularly since the start of the calendar year.

Some facts:

As of a couple of weeks ago, one of the world’s best brokers in this area (Jefferies) put out a couple of notes stating that:

There are currently over 125 Small / Mid cap biotech stocks which are trading at, or below, cash backing

  • This represents approximately 25% of all NASDAQ-listed Small / Mid (SMID) cap biotechs (defined as having a market capitalisation ≤ US$5 billion)
  • The ‘normal’ number of stocks historically trading below cash in this sector averages 10 – 20
  • The highest number prior was 43

Big Pharma currently has aggregate cash levels equivalent to the entire SMID cap sector

  • i.e. big pharma could essentially ‘buy the lot’ (ignoring takeover premiums)
  • M&A activity in the sector has been relatively quiet in the past 12 months
  • The dynamic of depressed prices and cashed up buyers presents an interesting scenario moving forward

The significant downturn in general prices in the sector is largely driven by the formulaic way that analysts use discount rates for their (standard) discounted cash flow valuations. With the spectre of inflation on the rise and interest rates rising, upward adjustment of discount rates (and analysts are tweedle dee and tweedle dum in this regard) has had the effect of significantly revising down the prices that people will pay for great long-term assets.

As an example, we have had several of our holdings report outstanding clinical trial results in recent times only to see their stock prices fall. And this is against a backdrop of our risk management rules and investment protocols being particularly severe on companies we feel don’t have adequate cash reserves.

It is crazy.

And in cold blood, a good long-term investor would be crazy not to look at taking advantage of it. We have been, and continue to be, a net investor in this time of fear.

So back to history rhyming and the leap of faith. Such a leap of faith is invariably most difficult when markets are most deeply depressed. But if history teaches us anything, it is that this is also invariably the most financially rewarding time to leap.