Letter from America

Jan 17, 2023

2022 has certainly been a rollercoaster year for equities in general, and biotech in particular.  We started out the year with inflation proving far more persistent than transitory, with the response from central banks being aggressive quantitative tightening, leading to a broad equity market correction.  For biotech, this manifested in the largest correction in the index’s history, dropping ~40% in the 5 months to 31 May 2022, with this coming on top of a ~20% fall over calendar year 2021.

Despite a recovery in the second half of the year, all major US indices ended calendar year 2022 in the red.  HB Biotechnology, however, fared much better, with the full year scorecard as per below:

2022 Performance before fees

More broadly, our performance to 31 December 2022 for a range of periods is as follows:

Performance before fees

Letter from America

Most of the observations in the report below were formed whilst visiting the US in late December 2022 to meet with both existing and prospective HB Biotech portfolio companies, as well as other industry contacts – it was a most fruitful trip.  I hope you find this ‘Letter from America’ of interest.

The view from a Biotech company’s perspective

Over the many meetings we had with US-based biotech companies, it was clear that 2022 had been a tumultuous year, with many small to mid-cap companies (still) trading at significant discounts to their 2021 share prices.  In fact, unlike many other broad-based equity indices, global biotech remains below pre-Covid levels. This makes us sanguine about both near and mid-term prospects for the sector.

While capital markets for biotech in the US, and elsewhere, were almost completely non-existent until June 2022, the second half started to open up.  Biotech companies with good data and solid management were being rewarded, evidenced by US$11b in secondary offerings in 2H 2022.  In contrast, the IPO market remained almost completely shut with less than US$2b in total proceeds over the entire 2022 (compared with >US$14b in 2021).

Additionally, the second half of 2022 started to see the re-emergence of M&A activity from large cap biopharma.  Anecdotally this pick-up in M&A was perceived to be, in part, due to sellers having more realistic price expectations.  This, combined with the nearly $300b in cash held by the top 15-20 global biopharma companies who have publicly stated their desire to increase M&A, assisted the biotech recovery in 2H 2022.

Looking into 2023, all companies we met with were planning for the worst, but were optimistic about the future, confident that the market lows experienced in May 2022 are behind us.  In practice this translated into being highly conscious of their cash runway, seeking to not be under pressure to raise further capital in 2023 – or if they must, it should be from a position of strength with excellent clinical data.

The ‘regular’ US citizen’s perspective

While travelling through the US, apart from meeting with biotech companies, it was also an opportunity to talk to the locals to get their feedback on the economy and how it was impacting them.

Certainly, all those we spoke to had felt the bite of inflation, predominantly in food and gasoline prices. However, while acknowledging a likely sampling bias, most US locals we surveyed were confident of a ‘soft landing’ – i.e., the US would avoid a recession.  Few, if any, had job security concerns, reflecting the official government statistics that the labour market, overall, remains tight in the US.

So what does this mean for 2023?

While consumers seem to be shrugging off the possibility of a US recession, the best managed companies appear to be preparing for this potential eventuality (quite prudently in our view). At HB Biotechnology we are (always) seeking to align our portfolio with companies exhibiting solid balance sheets to mitigate against potential surprises. For this reason, a very important component of our Risk Management Rules is always ensuring our investments have minimum levels of cash reserves at all times.  It is an approach which served us very well during the recent downturn.With global biotech prices still below pre-COVID levels, we believe that the recovery in biotech will continue into 2023, and good companies with solid management and quality clinical data will continue to be rewarded.

It is also important to note that the fundamentals of biotech are linked to healthcare which is less impacted by consumer demand than many other industries. As a result, and as discussed in our last update, global biotech has a very low correlation with overall equity markets.  In fact, despite higher volatility, due to the low correlation with a conventional ASX portfolio:

A 10% exposure to HB Biotechnology has consistently delivered superior returns with negligible impact on overall portfolio volatility.

Putting this in context, the table below shows the average incremental return, volatility and Sharpe Ratio (a measure of risk vs reward, the higher the better) when adding various weightings of an HB Biotechnology portfolio to an ASX200 portfolio:

Average 5 year return, volatility and Sharpe Ratio (monthly rests) since HBB / CW inception

Why is this important?  While we can never know for sure what 2023 will bring, constructing an investment portfolio with low correlation assets can help enhance investment returns while mitigating against any uncertainties ahead.

In all, we continue to find compelling investment opportunities in this market, and believe the biotech sector remains inexpensive. Here at HB Biotechnology, providing investors exposure to global biotechnology through a portfolio of actively managed, listed investments, we believe the recovery from recent lows has further to go.