Don’t worry if you missed this week’s event with International Biotechnology Trust (IBT ) fund managers Ailsa Craig and Marek Poszepczynski as you can watch the whole one-hour recording here!

In their presentation entitled ‘The stars are aligning’, Craig and Poszepczynski highlight how the easing of interest rate pressures is allowing the strong fundamentals behind drug development and healthcare to shine through after a difficult few years.

The managers, who moved across with the trust to Schroders from SV Health last November, show how their stock selection identifies the companies that are best commercialising scientific breakthroughs and may be attractive to increasingly acquisitive large pharmaceutical companies.

Faced with an inherently volatile sector, the managers explain how their active trading of stocks protects the £287m trust from the ‘binary’ win-all, lose-all outcomes of drug trials.

Their asset allocation calls of when to move between large and smaller companies also helped shield IBT from the worst of the downturn, making it the best performer in its peer group over 10 years, with a 181% total shareholder return. This beats the 124% from the Nasdaq Biotechnology index and the average 112% return of trusts in its sector.

In the one-hour programme, Craig and Poszepczynski also answer questions from Citywire’s Gavin Lumsden and investors.  

Can’t watch now? Read the transcript! 

Gavin Lumsden:

Hello and welcome to International Biotechnology Trust, the stars are aligning. A one-hour programme brought to you by Citywire and Schroders. My name is Gavin Lumsden, I’m from Citywire. With me in the studio are Ailsa Craig and Marek Poszepczynski, portfolio managers of the International Biotechnology Trust who last year followed the company on its move from SV Health Investors to Schroders. They’re here to talk about why the recent rally in biotechnology stocks is more than a flash in a lab test tube but a return to normality for a sector whose products are in increasing demand by ageing populations. Ailsa, Marek, very good to see you.

It’s the usual format today. The managers will shortly give a presentation. I’m then going to ask them some questions and then it’s over to you for Q&As in the last section of the show. Ok, let’s get down to business. Ailsa, Marek are you ready to give your presentation?

Ailsa Craig:

Absolutely. Thank you for having us. So, kicking off you’ve got, as Gavin said, Marek and me here to run through why we think now is a good time to invest in biotech and a bit about the trust. Marek and I have been working on the trust for 26 years now. I Joined in 2006 and Marek in 2013. So a huge amount of experience for this trust alone, but we’ve both been following biotech, in various capacities since the early noughties.

So, you mentioned the move to Schroders. IBT moved back in November last year from SV Health Investors and this chart shows quite nicely how we slot into Schroders’ healthcare product offering, if you like. So, they have venture on the lefthand side of this chart. Then on the righthand side, they have funds in pharma and large-cap healthcare and we slot quite nicely into that, with a blend of venture and some stocks, for example, that are slightly larger-cap in size.

So just as an overview. Biotech, as you know, is the innovative part of the pharmaceutical industry. We’re seeing more and more drugs coming into the market. They’re generally, mostly discovered in universities, developed by biotech companies, and often picked up by large-cap biotech and large-cap pharma names. So, this is the engine of innovation. Performance for the trust has been strong. Our net asset value has outperformed over one, three, five and ten-year basis to the end of January 2024.

Volatility has historically been lower than our benchmark. We’ve picked that up a bit and I’ll come on to why that is later on. We do have a dividend yield. So, 4% of NAV is paid out to shareholders twice a year in two instalments of 2%. Then backed by an expert team. So, Marek and I are coming up to our third-year anniversary in March. So, in a few weeks’ time. Where we have been co-lead fund managers of the trust. I mentioned that we’ve obviously worked on the fund going back many years.

There’s also our 30th anniversary. So, the fund itself was founded back in 1994. So, this year, in May, it’s 30 years of IBT. Then finally, as I mentioned, we moved over to Schroder Unit Trust Ltd back in November of 2023. So that’s a little overview of the trust. In the next few slides, Marek will talk about the long-term drivers of the biotech sector and then I’ll come back in and talk a bit about portfolio analysis and how we manage the fund. So just to touch, actually, I missed this slide. Performance-wise, I mentioned we’ve outperformed on a NAV basis for one, three, five and 10 years, you can see on the top left.

What I should mention is that on a share price basis, we’ve slightly underperformed on some of those time metrics and that’s because the discount has widened. We have seen widening discounts across the whole of the investment trust market. We have a buyback mechanism that hopefully, over time, will reduce that discount. So, Marek, over to you, to talk about the longer-term drivers of the biotech market.

Marek Poszepczynski:

 

Thank you, Ailsa. So, if you look at this slide, globally we are getting older, greyer, the world is greying. Population is growing, but mainly in the older population cohorts. In this slide, you can see the population above the age of 65 will quadruple or triple over the next 60, 70, 80 years. That means that the growth of elderly population is growing. This is the time point in life where we get the ailments, the diseases when we need treatment. This is a very good long-term tailwind for the sector and if you change the slide...

You can also see that the industry has followed suit. On the lefthand side you can see the ongoing clinical trials in the US, which is the major source. You can see that the number of clinical trials have doubled the last decade. On the righthand side, you can also see the number of drug approvals which slowly, but surely, is grinding upwards. We have a small down year 2022, mainly due to the Covid pandemic. Over time, you can see a gradual increase on number of approved drugs.

Rising drug sales

Coming back to this, is the global sales of drugs in the world. As you can see that it’s growing on a steady pace, irrespective of the economic backdrop. Politically, this is the last thing you cut down on when you do cost cutting, but also personal spending, healthcare is very important. As you can see, the projection shows around 5% annual global growth. With that 5% bucket, you also can see, which Ailsa will come back to, the number of patent expiries which is baked into this, which means that the new drugs approved grows much faster than the 5% shown in this slide.

Also, I want to point out the orphan space in the bottom line, which is meaning that it’s a very rare disease. This is why it’s called ‘orphan’ and you can see that part of the industry subsector grows at twice the speed of the rest of the industry. Orphan diseases affecting children, genetic diseases are very severe ailments and in IBT we focus on these which address very high medical needs.

When I started in the industry 20 years ago, we had small molecules where you synthesise in the lab and you have monoclonal antibodies which is a new thing in the drug development space. The industry is branching out in a very high speed. Their innovation is accelerating, I would say, rather than being-, it’s so quick, it’s very hard to keep pace. This slide shows a spectrum of the new treatment modalities that are available now in the world. On the lefthand side you can see cell-based therapies. Basically, take cells from patients modify them, expand, and put them back into the patient.

Those cells actually act as a medicine. They attack the tumours. Sounds a bit science fiction, but we have had drugs on the market for several years and have revolutionised certain segments of the industry. Gene therapies. Every year we get better, better at modifying the genome. We’re getting better and better. You can see on this slide several drugs have been approved. Revolutionised certain diseases. RNA therapies. The Covid pandemic was stemmed by Moderna Biotech developing vaccines with this technology.

The latest addition is gene editing, which is a subsegment of gene therapy. All of these treatment modalities have drugs approved on the market and we will see iterations of this coming forward in the coming years. So, we see a lot of innovation coming through.        

Rate-sensitive

Coming back to the equity side of the biotech industry which we are talking about today, I want to point out the interest rate movements on the XBI, which is the small-cap index of biotech. The light green shows you that the interest rates, as soon as they go up, the biotech industry or the small-caps, are affected. One of the reasons is that the industry is very affected by long-term interest rates. That it takes ten years to develop a drug, which means that interest rates and the cost of money is very important for these companies.

As soon as interest rates come down, you can see the industry is responding in a positive way. One of the reasons why the industry usually, historically have performed relatively well in recessions, because this is the time point when interest rates are coming down, but also, counter-wise, tend to not do particularly well when the market is very hot and the industry is full throttle and interest rates are moving upwards.

[TEN MINUTES]

So, this is a long-term picture of the last five years, when the MBI index, which is the market-cap weighted biotech index and the light green is the small-cap index. You can see, the last five years, when the pandemic hit, you can see there was an imminent 30% reduction of prices, but after that we had the Fed coming in and we had low interest rates. You can see the XPI index almost tripled during that period, which was only during one and a half years. Since then, retracted everything. 70% back. As you can see on this slide, we have had a small rebound, but in essence, we are back to the same levels we were five years ago.

The biotech cycle

Ailsa Craig:

So, each month, we write a blog with ideas, generally, from what clients are asking us in marketing meetings. This one has been particularly popular and often, we get questions of why does a sector go in and out of favour? It seems to do it in a quite extreme way and we’ve seen this happen in recent years. So, we wrote a blog, talking about how we often see in this sector, bubbly valuations. Things get overheated and the inverse of that is true. Things can get oversold. So back a couple of years ago, June 2022 or just prior to that, we had what we would consider a despair situation.

So, valuations have come down a huge amount. Lots of companies trading less than the cash position in their bank. Then we had what we called a recovery stage and we think we’ve been through that stage. So, M&A [mergers and acquisitions] picked up. So, in 2023 we had record numbers of M&A deals and pharma companies buying up smaller companies. We think we’ve just moved into stage three, equilibrium. The reason behind that is because we’re seeing good data for numbers of follow-on deals coming through for biotech companies. Numbers of IPOs [initial public offers or flotations] coming on.

So, we think we’ve just ticked into stage three. More normalised market. If we get a euphoria situation, we’ll be in stage four again and then there’s a correction, M&A drives up, etcetera. So, we have this cycle. It’s not just biotech, you get them in lots of industries and in equities as a whole. It certainly seems to be quite extreme in biotech.

So, as I just touched on, we’ve had some promising green shoot data out of money raising this year for the industry. So, on the righthand side, you can see up until mid-Feb, I think Jefferies had a note out saying that $6 billion worth of follow-ons have happened already this year. It could actually, maybe beat the latest high, which was second quarter 2021. So that’s really promising. IPO numbers also ticking up. So, it looks and feels like investors are moving back to the sector again. We’re certainly optimistic that’s the case.

Big pharma losing patent protection

So, M&A. I mentioned last year we saw some record numbers of M&A deals. Why is that? Well, this slide shows you the predicament that big pharma is under. It tends to be-, there’s no reason behind this, but IP [intellectual property] expiries come in waves. We’ve got a wave of IP expiries towards the end of this decade. We’re talking big pharma having major drug sales coming off patent. So, this chart shows that increase in IP expiries, in terms of billions of dollars coming off patent. This means that they’ve not only got-, in order to growth their topline, they’ve got to fill that void of IP expiries and grow on top of that.

So how do they address that?  They can do internal R&D or they can acquire companies that have already successfully achieved that, depending on what sort of risk they want to take. So, we’re seeing the need for M&A and its being borne out in the numbers.

We’ve had a good hit rate on deals. So, this chart shows all of the acquisitions from the trust since 2020. We’ve had 23 deals within the portfolio in that time. Below the X-axis, the deals that have come out of the unquoted, the venture part of the portfolio, but above the X-axis, are all the names out of the quoted portfolio. So that’s been very promising. It’s been helpful for our NAV returns.

Vera’s a winner

Couple of examples of stocks. So, Vera Therapeutics has been a big winner for us in recent months. Marek used to work in the IgAN space, in the kidney space, in industry. The company reported early phase two data back January last year. The market didn’t like it, share price fell quite hard. Marek had a different view and we moved in and took a relatively big position for a company of that size at the time. About 500 million market-cap. Since then, they’ve announced more and more positive data and then I think the market’s come round to the view that actually, this drug is doing something really interesting.

The next stage for these guys would be phase three. So, the last stage of clinical development data, probably next year some time. At the moment, we’ve had phase two data. So, we’re in that sweet spot where there’s not much news and less risk on a clinical development basis.

Another good example in the portfolio, in our top ten, is Cytokinetics. This company has been derisked, in our view, in terms of the clinic. So, it’s had their phase three data. It looked really promising. It’s competing in a market that there is already a drug on the market, but this drug looks much more promising in terms of efficacy and safety. So, they need to get through the regulator, but we don’t think that there should be a problem on that front. Should note that the competitor drug that’s on the market, the scientific team behind this programme helped develop.

So Mavacampten was made by MyoKardia, which is the drug for hypertrophic cardiomyopathy on the market now and Bristol Myers acquired that company for 13 billion. So, we like this asset. We think it’s relatively derisked. Maybe could get picked up in the future as well.

So, moving on to the portfolio. Idea generation. Most of the companies that we’re invested in are based in America. The reason behind that is because that’s where the funding is. These companies, it takes a lot of money to develop a drug and it’s certainly not so much the innovation in the early stage, that’s very much more balanced between US and Europe, but once they start to get big bucks to get the drugs through development, they tend to either go and list in the US or they are American companies themselves.

Trading discipline

So, idea generation. We visit America and we do to investor conferences and we also have access to the Schroder healthcare platform, so we can discuss with our colleagues about new ideas and we have regular meetings with the companies themselves. Risk mitigation. We have various different tools in our box, to try and lessen the loss of capital. So, you’ve be aware that if there’s a negative clinical trial for a drug, a share price can fall quite dramatically.

So, what we try and do is understand when those events are going to be and reduce the exposure we have in the fund going into those events. We are valuation sensitive. So, we will take profits if we think a company is looking fully valued and we are actively trading the fund every day. So, we have this trading discipline. On the macro side, we keep one eye on the interest rates, the business cycle. We can gear the fund if we’re optimistic and we can take that gearing off on a short-term basis. Again, it’s an actively managed tool in our toolbox.

Then asset allocation is another thing we can use to tilt the fund’s beta if you like. So, we can move into large-cap if we think things are a bit overcooked. We can move back into smid-caps [smaller and medium-sized companies] if we think things are looking good value. That’s the position we’re in right now. We’re dipping our toes back into the smid-cap market.

This is a snapshot of where the fund is right now. If you have a look at the top righthand side, this is something that’s not as well understood as maybe people could be, which is that the sector in the US is very established now and it’s reflected within our fund. So over 40% of the trust is invested in profitable companies. Then just under a third of the trust is invested in companies that are selling on the market. So, the drugs have been through the clinic, been through the regulator. They’re making money at the top-line, they just haven’t yet turned a profit.

Just over a third, which is high, relative for us, actually, are in the traditional early stage, development stage companies. On the top lefthand side this talks about the actual size, the market-caps of the companies that we’re invested in. Again, some of these companies are mega-cap companies. Bigger than Glaxo and bigger than Astra. Bottom lefthand side, which shows what disease areas we’re in. So, Marek mentioned that the orphan or rare disease part of the market’s growing faster than other drugs on a prescription basis. So, we like that area.

That’s why we’ve got them as the highest position in our fund. We like oncology. Why? Cancer is an unmet medical need and there’s pricing power there. We like CNS, central nervous system for things like mental health. I mentioned already, that the majority of the fund is invested in US listed assets.

Here is our top ten. We release this every month in our fund sheet. You can see Vera there at the top. We’ve been reducing our position in Vera, taking profits in this name after a strong run. There’s a whole cross spectrum of sizes of companies. So, Amgen is a large-cap, over $130 billion in market-cap. All the way over to small-cap companies like Supernus, just over a billion market-cap. So real range of company sizes and risk profiles.

[TWENTY MINUTES]

Then I mentioned the [share price] discount widening. This chart at the bottom shows our discounts. We do, do buybacks if we’re trading at a discount. We don’t have a number that we give out as a line in the sand, but you can see roughly where we start buying back stock on our RNS announcements. Then if we do to a premium, we can issue shares and grow the fund as well.

‘Smid’ focus

Key investment themes. We’re moving into smid-caps. I mentioned that’s where we see good value at the moment. We should also mention that M&A is looking like it might go down the market-cap spectrum as well. So, pharma might be looking to go in the same direction. We have obviously, got this issue with large-cap pharma facing big patent expiries at the end of the decade. We use our gearing tactically. We have one eye on the FTC, which is that some of these big pharma deals are being investigated by the US equivalent, the FTC of the Competition Commission, but they haven’t actually achieved anything on that front. Those deals are settled and have gone through.

The approach that I haven’t mentioned, actually, is to mitigate risk, which obviously, this sector is risky. On the lower-end of the market-cap spectrum we can take baskets of stocks. Instead of trying to back one horse, maybe we’ll cover a few names that are having different approaches in a disease area. We did that in the kidney space and actually, one of our names, Chinook, was acquired by Novartis and that lifted the whole basket up and Vera is within that basket as well.

I mentioned that we still consider macro and we tilt the fund, depending on the risk profile and one thing as well, is that because we’ve had such a large number of deals within the fund, we are redeploying that cash and reinvesting that cash into the smid-cap market. The way we see the dividend payment, it’s almost like we don’t have investments in companies with a natural income, but we do have cashflow into the trust from exiting these deals.

I should mention the unquoted part of the portfolio. This is managed by SV Health Investors still. That will remain the case. We have two investments in two of their funds. SV Fund 6 and the biotech crossover fund, which is a relatively new investment. The board have a threshold of 5% to 15% exposure into this side of the biotech market. The goal being, that shareholders and investors that invest in IBT get exposure to the industry all the way from ideas coming out of university, which is this zone. All the way up to mega-cap biotech. So, they have the whole industry exposure when they buy IBT Shares.

Then, here’s a graphic showing the dividend payment each year. Two instalments, as I mentioned. A nice gradual uptrend over time. It is pegged to NAV. So, if the NAV falls, the payment will fall on an absolute basis and if the NAV rises, the payment will rise on an absolute basis. I think that comes to the end of the presentation, hopefully haven’t run over and we can crack on.

How important is the science?

Gavin Lumsden:

I’ve got a few questions, but just to remind the audience. Received one question so far, going to see more to come, I hope, do send them through and we’ll get to them later. In the meantime, Ailsa and Marek. I just wondered to start off with, how important is the science in biotechnology? On the one hand you highlighted the range of pioneering companies that you invest in are pushing all sorts of medical developments. On another, you indicate that medical knowledge is just part of the investment process you go through. Where does the science lie in all of this?

Ailsa Craig:                      

It’s crucial. It’s vital. Good, strong, innovative science is absolutely paramount within our investment decisions, but we have to think about, is it going to be commercially viable. Is society willing to pay for this drug? Is there a medical need for the drug? Are the management qualified and experienced enough to get the drug to market? So, all of those factors we take into account as well. What we don’t do is buy and hold high science from the early stages all the way through because you can trip up in so many different ways. Another company, for example, could get a better drug and that’s no fault of the original scientist’s idea that’s fantastic. We want to be able to say, hang on a minute, we’ll sell that, buy that one. Those guys look better.

Gavin Lumsden:

Marek, the sector is, by definition, not a buy and hold sector, but one that you’re trading in and out of more.

Marek Poszepczynski:

Yes, to some extent that is true, but if you think about how a drug is developed, you have the scientists doing their core science things that our venture group with SV, with Kate, they’re investing a lot in these early-stage names and UK’s a big proponent of that and they find a lot of good ideas here, but that’s an idea. Making a drug of an idea, it takes a different skillset. You need to go through the regulatory framework. You need to do proper clinical trials. You can trip up on so many levels and it usually takes a decade to develop a drug.

Then you have the skillsets of the marketeers. They need to sell the drug and get reimbursed, etcetera. So, science is prerequisite for us investing, but you need to be very shrewd about it. To Ailsa’s point, you can be leapfrogged, you can have delays and this is our job, to find the good stuff that will be the next generation drugs.

Gavin Lumsden:

Ailsa, you just referred to a basket approach that you can take. That makes a lot of sense, but if you could say a bit more about how you balance conviction in one particular company versus its sector?

Ailsa Craig:                      

If we take the kidney example. We had four or five names in that basket about 12 months ago. One of them has been acquired, like I mentioned. The other one was a commercial company, we felt now is looking obsolete because Vera’s got such good data. So, we’re backing that horse. So, it’s managed depending on what data they’ve shown and what their different approaches are and what stage they’re at.

What did you do different in the downturn?

Gavin Lumsden:

IBT’s performance has held up better in the downturn than other biotechnology funds. Marek, what did you do differently from your rivals, to mitigate the impact of rising interest rates?

Marek Poszepczynski:   

As you saw in the previous slide, the biotech index went up meteorically. 300% in 18 months. It peaked at the time Ailsa and I took over. So, coming in at the peak was a very interesting moment for us. We took the decision saying, this market is overcooked. Biotech shouldn’t be worth that much. We like it fundamentally. Over time that will probably correct itself. At the moment, we didn’t believe that would hold. So, we had a correction. We sold off the exposures we had in the smaller names and invested more in the high cashflow generative market-cap weighted biotechs like Amgen, Gilead, Biogen.

The generators of cash, maybe not super innovative, but they held their value. In the first six to 12 months, the market corrected and that was a correction because biotech was overvalued. Then we had another round when inflation started to hit and interest rates started to move up. Then we had another correction that was more driven by macro. We held steady. We believed it needed a correction and once it stopped, we started to redeploy the money. So, in a way we escaped or survived between 2021 and 2023.

There is a point in time when the market will turn and we have seen it tends to move very viciously in the beginning. As you can see on the slides we present, it can move very quickly and you have to be well-positioned well in advance.

Biotech does well in a recession

Gavin Lumsden:

Ailsa, this point about the sensitivity to interest rates. What Marek said made total sense at the time, it does seem counterintuitive that biotech is doing well going into recession.

Ailsa Craig:                      

Traditionally, it doesn’t do well going into recession because interest rates rise. Once the recession hits performance of biotech, surprisingly, outperforms the market. Goldman Sachs did a report and they looked at the last five recessions and biotech outperformed four out of the last five recessions. It’s probably because they were so beaten up going into the recession. Then on top of that if you remember, these are drugs. People don’t try and cut back on spending when it comes to their own medications. They’re going to cut spending in other areas. So, there’s lots of reasons why that might be and who knows if there will be a recession, but certainly in the past, biotech has performed okay.

Do you seek bid targets?

Gavin Lumsden:

So, resilience there then. IBT has also seen, as you highlighted, 23 of the portfolio companies been bid for in the past four years. The three most significant deals, Horizon Seagen and Biohaven have been in the past two years. So, is this a coincidence or are you deliberately looked for acquisition targets?

Ailsa Craig:                      

I think when we decide to invest in a company, we’re looking for the similar characteristics that pharma’s looking for. So, it’s a slight coincidence, but also, we should mention. Marek, who has worked in the industry for many years, also worked in bus-dev in biotech. So, he knows how they think and he knows when a company is overvalued in pharma eyes. So, there’s probably a bit of both really.

Gavin Lumsden:

So, you’ve got some insight into the valuations and what they’re looking for and how much they might pay for one of the companies in the portfolio.

Marek Poszepczynski:   

[THIRTY MINUTES]

To some extent. There is certain characteristics pharma is looking for. Many of those are internal politics going on in these pharma companies that sad enough, I’ve seen first-hand. In general, I did my first 15 years in the industry and seen a lot of projects and companies. It tides very well when discussing with Ailsa, regarding these companies and this is how we often end up investing in these because we think these characteristics suit pharma. Having said that, the key element of everything is that good companies get acquired. It’s not like we are looking for M&A primarily. We’re thinking this is a good company that can be acquired, rather than the other way around.

Some deals provoke the attention of the US Federal Trade Commission. What was the regulator worried about and has the threat of intervention receded?

Ailsa Craig:                      

The FTC investigated the Horizon/Amgen deal and the Pfizer/Seagen deal. So, at the time, Horizon was bid for by Amgen, it was our top position in the fund. Then Seagen became our top position, which was then bid for by Pfizer. So, both very helpful for NAV. However, the FTC, the equivalent of the Competition Commission as you mentioned, looked into whether that deal should go through. They’re worried about monopoly in markets, bundling of pricing, etcetera.            

So, the various different companies fought back and they’ve managed to get through the FTC issues and they settled and it’s okay. However, it does mean that maybe pharma’s going to be put off doing these big deals in the future. They don’t really want to be spending their time and money on cases such as this. So it could be that they, like us, are going down the market-cap spectrum and maybe trying to look at smaller companies that come under the radar of what the FTC are looking for.

Gavin Lumsden:

So, they wouldn’t raise competitive concerns.

Ailsa Craig:                      

Capacity-wise, they’re probably only going to focus on the big deals. So, we might see smaller deals.

Is there US election risk?

Gavin Lumsden:

This takes us neatly on to US politics. We’ve got a Presidential election looming. Previous elections have seen healthcare and drugs pricing become huge political issues. Is there a political risk this time?

Ailsa Craig:                      

It’s always used as a political football in America going into the election, drug pricing, as you said. It’s a great headline grabber. Hopefully, this election cycle, either it will be further down the list of things that will be discussed. Deprioritized, if you like, because finally, the Democrats did pass legislation in amongst the Inflation Reduction Act to allow Medicare to negotiate for drug prices. So, the Republicans aren’t going to start waving this around because the Democrats can say we did something about it. So, it might not be top of the list of debate. Who knows, we’ll see what happens.

Gavin Lumsden:

In the meantime, market sentiment is improving. Recent rally and your share price shows that. In the US, the home of biotechnology it seems, flotations and IPOs are returning. Have you backed any of the companies that come to market this year?

Ailsa Craig:                      

Yes. So, there’ve been six IPOs and last year, there were 17 in total. So, it’s looking like a promising number. We’ve looked at one particular one, but we haven’t invested in anything yet. What we tend to do is stay on the sidelines, wait for the lock up on the venture investors to come off, which tends to be about six months in and then you might see an opportunity to invest and get to know the company. We may invest in them if we want to. We can invest across the whole cross spectrum of biotech companies. We just haven’t done this year as yet.

The role of venture capital

Gavin Lumsden:

That takes me on to my next question around the unquoted part of the portfolio that SV Health, your former employer runs. I guess you don’t need to be quite so focused on flotations if you’ve got-, one of the SV fund’s you’re investing, this crossover fund. So late stage, private equity, companies that are hoping to float. You’ve got that bit covered I suppose.

Marek Poszepczynski:

To some extent we have. To Ailsa’s points regarding IPOs, we have a lot of testing the water, companies coming to us asking if we’re interested to listen to their story because this is how IPOs are made. You tend to get the interest first. They travel around and test the water with investors like us. So, we have seen a pickup in that, which means that we probably will see IPOs coming through in a higher volume than we have seen before, if all else is equal and the economy holds up, etcetera. So, this is where we’ve seen the activity coming up. So, it’s not only six IPOs, that’s not how it works. You can see the flow coming through as well.

Gavin Lumsden:

Ailsa, it’s about 8% is allocated to unquoted at the moment. What is the role of venture at the moment? You used to work at SV Health, you obviously moved across, but SV Health is continuing to provide that exposure for you.

Ailsa Craig:

The board decides how much to invest in this side of the market. At the moment, they have a threshold of between 5% and 15% of NAV to be invested through venture funds. Currently, two of those funds, SV Fund 6 and BCOF are managed by SV Health Investors and they will continue to do that. No noises at all from the board that they’ll change that threshold. It’s a nice sweetener to the trust. Like I said earlier, it gives shareholders access to the innovation coming out of universities and ideas coming out of universities, all the way up to large-cap funds. So, business as usual on that front. Like you said, it’s just shy of 9% of the trust right now. So nicely sitting in between the board’s range of 5% to 15%.

Huge Nimbus gain

Gavin Lumsden:

We talked about M&A and the bids that have juiced up returns nicely the past year or so. One of the funds, this crossover fund had a huge success in one of its investments. A company called Nimbus. I was reading the annual report. Wasn’t sold, but it sold a key asset, a key drug and made $4 billion. How much does the trust get of that?

Marek Poszepczynski:   

That’s a question we are not allowed to disclose unfortunately. We can say it was a nice contribution to the NAV. It was a very good return and we’re not complaining.

Gavin Lumsden:

So that shows that on the unquoted side, big one-off deals come along, but how unusual is something of that scale?

Marek Poszepczynski:   

If you think about it from a venture perspective, this is why we have 5% to 15%. Usually, you have one-, say you invest in ten venture companies over a lifecycle, you might have one or two that are super hits and then you have maybe two or three that make returns, but they’re not spectacular. Then you have six, seven that will fail. That’s the life of a venture and this is how it operates. So, the returns are quite bulky, which is why it’s so nice to have a small portion in the portfolio. Over time, it should generate more returns, but that’s historical. You never know how that will work in the future.

Why are you in London?

Gavin Lumsden:

That’s all my questions for now. Let’s turn to what the audience have been asking. Start off with Andy Clapham, thanks for the question, Andy. He’s asking, ‘Most of the industry and funding is in the US, why manage the fund from London?’

Ailsa Craig:                      

Our shareholders are based in the UK and we do like to keep them up to speed with what’s going on. You’re right, on the public side, the US market certainly dominates the holdings that we have in the trust. It’s not true on the venture side. Kate, if she was here, would definitely bang the table and say, there’s tonnes going on in the UK market on the venture side. Lots and lots of ideas coming out of Cambridge, Oxford, etcetera. So, it’s not necessarily all going on in the US. There’s a lot going on in the UK as well.

Marek Poszepczynski:

The ecosystem is built this way. The companies that start in Europe, which in the startup arena probably is not that tilted towards US as the funding is, but once the company becomes mature enough, they tend to move to US where you have more financing strength and this is how it works in the industry. It’s always been that way.

Gavin Lumsden:

So, you have to travel a lot though. You’re referring to companies you’re going to. You’re going to the States a lot I expect.

Ailsa Craig:

Exactly. We travel a lot to the US. We also have a Schroders office in the US and a healthcare analyst based there too. So, we can always negotiate and discuss ideas.

Marek Poszepczynski:

A lot of companies for the US come to Europe because they obviously want European investors to invest in their companies. So, they have a lot of roadshows coming specifically to London.

Gavin Lumsden:

Now you’re at Schroders you’re probably getting access to even more companies I expect. So, Colin Flockton asks on diversification: ‘Have you said how many holdings you have in the trust?’ He’s interested to know how many quoted and how many unquoted.

Ailsa Craig:                      

We’ve got over 70 on the quoted part of the portfolio and then in the unquoted part, I think it’s mid-20s. 24, 25 and diversified across the fund. So, you’re taking more of the risk away.

[FORTY MINUTES]

We used to invest directly in venture companies, now we invest in a fund. So those too add to the diversification of the fund.

What if rates are higher for longer?

Gavin Lumsden:

Robin Heeley’s asking about interest rates and where we are in the economic cycle. ‘Interest rates in the US and UK are now seen as higher for longer. Do you see any risks of recession in these economies?’

Marek Poszepczynski:   

It’s not something unusual. People have been speculating about that since we had the yield inversion coming through and it was more than a year ago and historically, that has been the case. We cannot think about what the Fed will do. What tends to happen is not only the absolute interest rate, it’s actually the direction of the interest rates that make a difference on valuations. If we see a high spike in interest rates, then of course, it will affect biotech. If it’s flattened out, it might not actually be that bad. It’s the direction of interest rates that actually causes the damage or positive for the sector.

Gavin Lumsden:

There was a lot of excitement end of last year that rates had peaked and were going to come down quite soon. That seems to be receding somewhat. So that higher for longer, is that dampening exuberance at the moment?

Marek Poszepczynski:   

If you look at the share price in October, November, December, you obviously saw the XBI [smaller company biotech index] went up a lot. The expectation that the Fed will lower the interest rate. We are more cautious about it because we have seen historically, inflation is very hard to actually put back into the bottle. We have been very cautious. We have not gone full tilt on our gearing. As you can see on our latest factsheet, it’s not 15% as we have had previously. Who knows about the future, but we are fairly cautious and if you look at our holdings, to Ailsa’s point, around 70% of our holdings are in revenue growth or profitable names that tend to be doing better and they have their own generating cash power.

How do profits vary in the different sectors?

Gavin Lumsden:

Anonymous asks, ‘How does the potential profitability of a company vary when you look at rare disease or orphan versus a more common disease like oncology or kidney?’ On the back of this, ‘Does public health funding flow for orphan drugs compared to the more normal drugs for common diseases?’

Marek Poszepczynski:   

It’s a complex question and I will try to answer that. I, myself, worked in the orphan space in the beginning of my career. What tends to happen when you finance orphan drugs, is that you need to spread the cost over the whole country because there are certain pockets. Maybe they have accumulation of certain orphan diseases and the local authorities might go bankrupt if you have to treat 100 people in the same area. Just an example. So, it’s more at a national level and you reimburse it from a national point of view. So usually, companies tend to negotiate more on a country basis. This is how it works.

Whereas when you talk about more general diseases, you tend to have more of a step in a way. First you go for the disease or for the medication that is generic. Works in the majority of patients. If it doesn’t work, you get stepped up into more advanced and more expensive drugs and that applies with cancer as well. It’s a bit different in the US when you have private insurance, when you pay for premium or less premium. A bit complex, but that’s the answer I can give you in terms of price. Profitability, orphan drugs tend to have better margins. That’s a fact because they can charge more. On the other hand, you have fewer patients and absolute profit will probably be less.

Ailsa Craig:                 

The clinical trials are smaller and tend to be shorter in time as well. So, it’s quicker to get a drug to market, relative to normal standard diseases.

Contributors to performance

Gavin Lumsden:

Thinking about performance, performance has been good. There’s a question here, ‘If you can say more about the biggest contributors and detractors to the performance. What’s worked well, not so well in the past three years?’

Ailsa Craig:                      

We’d have to go back to the annual report. I think there’s been some big his on M&A. So, Horizon being the largest company in the fund being acquired by Amgen. That certainly was a big contributor. As was Biohaven, which I think was 6% of NAV in the trust. Another top ten holding bought by Pfizer. Then Pfizer again, buying Seagen. Top ten holding. Top position in fact. So, M&A has definitely been a help to our performance. I think asset allocation as well, has been a big driver of performance relative to the market and our peers.

Taking the decision that we felt that there were pockets of bubble-like valuations. It wasn’t the whole sector that looked expensive in 2021, but we moved out of the areas that we felt were expensive. So, we can give an example. CRISPR Therapeutics was trading at a market-cap valuation of ten billion in market-cap and it hadn’t even had a product into human clinical trials at the time. Now, the product’s been approved and it’s low single-, three, four billion market-cap. So, it’s been through the clinic, it’s been through the regulator.

The mind boggles that the market can value a company at such a different stage of development, just because of where they are in the cycle of biotech. So, I think both those things contributed to our performance.

Gavin Lumsden:

We’ve talked about the US, but Martin Hall wants to reflect on the UK. ‘The UK sector seems to be suffering enormously from the lack of capital going into the sector. Where it does happen, institutions are demanding their pound of flesh.’ So very detrimental to existing shareholders. What are you seeing in the US(sic) biotech, is their plenty of support for capital increase?

Ailsa Craig:                      

In the US?

Gavin Lumsden:

Yes.

Ailsa Craig:                      

Yes. We saw that even during the downturn, actually. High quality companies with good datasets, could raise money. It was the low-quality companies that had been weaned out. So, what we’re seeing is a cleanup of the sector. We had an IPO market where companies were listing that probably shouldn’t have listed. So maybe weren’t in the clinic yet. That really painted the picture of things looking a bit bubbly. Now, we’ve had a bit of a glut of IPOs. So not so many companies coming onto the market.

Companies have gone out of business. We’ve seen consolidation of companies. So, all the different ways of consolidating during a downturn are something that has happened in the past in other downturns. So, it’s a cleaning up of the sector. So, our universe is now smaller than it was a few years ago, but higher quality.

US pharma review

Gavin Lumsden:

Ash is turning your attention back to the US. You said that with fiscal scrutiny, drugs and healthcare might be less of a fiscal hot potato, but Ash wants to ask, ‘What do you anticipate as the fallout from the US house committee review of big pharma pricing?’

Ailsa Craig:                      

I think the industry itself will shrug this off. They’ll say the usual rhetoric which they do. We don’t personally think it’s a massive risk. Like I said, again, it’s constantly up for debate. The industry is constantly under the spotlight. We’re used to it. Business as usual on our front. We stick to the innovative side of the market and leave the larger-cap pharma side. It isn’t really much within the trust anyway. So, we stick with the biotech, innovative side of the industry.

Marek Poszepczynski:

What I think is very important to take into consideration. As a proportion of GDP, US spends around 18% of GDP, but only 10% of that is actually pharma spend. So, I think that is very important to take into consideration. Even if you cut all the healthcare or pharma spending, you still would spend 13% to 15% of GDP on healthcare. So, it’s only a sliver of the totality of the cost. Often the medication keeps people out of hospitals and I think that’s a debate they have, the lobbyists at least, in the US.

Is there AI in the portfolio?

Gavin Lumsden:

Obviously, last year and the year before, dominated by the talk around Artificial intelligence. Again, Ash is asking, how is the use of AI represented in the portfolio or in the management of the portfolio?

Ailsa Craig:

Biotech companies have used AI for a long time. The way they use it would be to screen for now compounds that could potentially be used in patients for various different diseases. They can use AI for understanding of data crunching, clinical data after a clinical trial. Ultimately, there is a bottleneck. Drugs need to be tested in humans at the end of the day. So, there’s only so much AI can do on that front.

Gavin Lumsden:

Robin Heeley’s asking, ‘You’re at Schroders and settling in nicely it would seem, but has the platform introduced any new investments to the trust?’

Ailsa Craig:

What we’ve done at the moment, I mentioned there’s a team over in the US. In London we’ve got large-cap coverage by John Bowler and there’s a venture team in Europe as well. So, we’ve had discussions with all of them, talking about various different companies and depending on their expertise.

[FIFTY MINUTES]

So it’s been really helpful actually, because whereas at SV we had the helpful insights of the venture community, we have all aspects at Schroders now. So large-cap, we can go to our colleague, John Bowler and say what’s XYZ large company doing at the moment? Thinking about what did they say at JP Morgan conference in January, for example. So, you get that two-way discussion, which is very helpful.

Does infectious disease deserve more attention?

Gavin Lumsden:

Terance Taylor was interested in your position in Gilead. He writes, ‘Gilead with good progress in the area of infectious disease, in number two in your holdings, with highest values and returns, but infectious diseases is at the lower end of your chart showing the percentage of sector investments. Given the major breakthroughs, for example, in RNA interference, doesn’t this sector merit more attention?’

Marek Poszepczynski:

One has to think about Gilead as a company that had massive success in HCV, Hepatitis C treatment, which they created a drug that cured HCV, more or less. Then they’ve had a fantastic HIV portfolio and basically, everyone that has it goes on treatment and chronically. You can expect a normal life expectancy for these patients, more or less. What they have not been successful in is new acquisition. They ventured into oncology, they have made many M&As, which subsequently didn’t show being fantastically good. Having said that and as you see, when we built our portfolio, Gilead is a very, very stable company. They generate a lot of cash and create lower volatility. So, it’s an anchor in our portfolio, in terms of how we invest.

If we didn’t have Gilead, for example in our portfolio, we would probably have higher volatility. That’s how you build a portfolio. It’s a really good quality company. RNA, if you want to discuss that, there are companies, Alnylam, Ionis, Moderna, for example, that work in that space and you can expose yourself. There are many smaller companies. You can read our-, full-year financial report that we have invested in. They have prospects and we think they have more potential than sitting within the Gilead portfolio. Maybe Gilead will acquire these companies eventually. That is how we view it.

Gavin Lumsden:

How do you and the board decide to reallocate returns when profit taking? Reduce gearing, borrowing, buybacks or new investments.

Ailsa Craig:

So, the board have various different decisions and then as investment managers, we have different responsibilities. So, we decide what companies to invest in. The board are in charge of the decision of how much to invest in the venture funds and what exposure there. They have given us a certain amount of gearing capacity, for example, but we can decide within that gearing capacity where we want to be. Then buybacks, they give instructions on how much to buyback in terms of stock and at what level. So that’s the areas of responsibility. The board meet once a year for a strategy day, where they can discuss the metrics around the venture exposure, for example or how many buybacks they’re doing. Then any changes they make will be disclosed to shareholders in the reports.

Gavin Lumsden:

In terms of the share price rating, what catalysts do you see for improving the share price discount at the moment?

Ailsa Craig:

It’s interesting because it’s not just us that’s been affected on the discount front. I think there’s a whole investment trust space has been trading at wide discounts. Healthcare actually has a relatively narrow discount versus other sectors. Certainly, on the public side of the business. What will rerate the investment trust space?  I’m not sure, we’ll park that one. Certainly, within our trust and competitor funds, for example, I think having better performance on biotech on an absolute basis. Seeing a recovery, seeing some of the green shoots that we’re already seeing this year. More of the same could help rerate the trusts. That would be great, we’ll wait and see.

Are you big enough?

Gavin Lumsden:

Someone else is asking around UK wealth managers. Lots of managers seem to be consolidating. So, they’re turning into big investors. ‘Are you big enough?’ £300 million market-cap.

Ailsa Craig:                      

Very good question. I think that’s partly why the board decided to appoint Schroders as the manager of the trust because they have such a strong marketing side of their business. They have something like 14 other investment trusts. A massive salesforce so that we can go out there and grow the fund for exactly that point. Wealth managers are getting bigger. So, we’re doing our best to address that.

High turnover

Gavin Lumsden:

Anthony Forsyth’s question around cost. ‘You’re active managers, trading in and out. What percentage do trading costs represent of the ongoing charge?’

Ailsa Craig:                      

We do have a high turnover. We turnover the fund about once a year and we will continue to do that. So, it’s a big turnover. We actively manage the fund. There are various different reasons behind that. It’s partly because we want to reduce our exposure in individual companies going into binary events, to preserve capital. Then we buy it back after the clinical readout.

Gavin Lumsden:

I was going to ask you about that. That is curious because there’s lots of binary events and some of them work in your favour and some of them don’t. If you’ve reduced a position in advance of clinical data and the clinic data is good, then aren’t you missing out on return?

Ailsa Craig:

We are missing out on initial return, but we would rather pay more for a derisked asset than lose-, sometimes you can have stocks go up 70%, 80%-.

Gavin Lumsden:

So, when you say derisked asset, you mean companies have good data, this works.

Ailsa Craig:

Exactly. Another thing that drives turnover is M&A. So, we had a huge amount of churn, if you like, having cash coming in for horizon, cash coming in for Seagen, cash coming in for Biohaven and then reinvesting that back. So that does boost our turnover quite materially because there’s just so much M&A going on right now.

Marek Poszepczynski:

Actual cost of trading is miniscule. It’s very, very low.

Ailsa Craig:

Very low single-digit basis points per trade now for the machine driven.

Gavin Lumsden:

While we’re talking about costs, want to say a quick word about your costs. It’s 0.7% annual management fee.

Ailsa Craig:                      

On the public [equities], yes. Schroders are charging, overall, it comes out at about 0.9% management fee for the trust.

Gavin Lumsden:

There’s a performance fee if you beat the benchmark. The Nasdaq Biotech by more than 0.5% a year.

Ailsa Craig:                      

Exactly, a hurdle of 0.5%.

Risks of gene therapies

Gavin Lumsden:

Mollie Ring, stock specific question here. ‘BioMarin, that company and others have struggled to realise sales forecasts for their gene therapies, how do you hedge against the risk of these companies failing to reach patients because of high pricing?’

Marek Poszepczynski:   

BioMarin is a very, very good question in terms of gene therapy treatment. What Ailsa and I discussed previously and when it comes to BioMarin is, frankly, we didn’t believe their Haemophilia A gene therapy would be particularly well-received in the markets. One of the reasons is the Haemophilia A treatment is relatively well served at the moment. Has been for many years. You can take an injection twice or three times a week. Gene therapy, once you have taken it, you are excluded for future trials.

Which means that if you come up with a better solution, a better gene therapy, actually, you will be excluded from clinical trials, which some patients don’t want to be. Thirdly, which I think is the biggest hurdle of this uptake in this particular gene therapy is that the duration of efficacy is around four or five years, what we have seen. It dwindles over time. So eventually you need to go back to the normal treatment you had before. That’s where, I think, BioMarin has struggled so far.

There are other gene therapies for SMA, for example, which Novartis acquired, which is much more lifesaving. Kids born with SMA and they sadly die within 18 months. This treatment, the gene therapy actually makes them survive and live on. This is why we like that part of gene therapy and the cost a $3 million tag is hard to absorb for society, I think, at the moment. So there needs to be a different pricing mechanism.

How much should we hold in biotech?

Gavin Lumsden:

Last question for both of you. A question we always like to ask on the show. Do you personally hold the trust? Do you have skin in the game?

Ailsa Craig:                      

Absolutely. Yes, of course.

Marek Poszepczynski:

Yes.

Gavin Lumsden:

You can’t give financial planning advice, but David Brown is asking, ‘If it were your own personal portfolio, would percentage would you invest in biotech?’

Marek Poszepczynski:   

It’s a very, very good question.

Ailsa Craig:                      

Well, if you think about GDP, it’s 20% of GDP on healthcare in the US. So, should your fund reflect that? In this call I’m going to say, yes.

Gavin Lumsden:

Nice answer! We’ll leave it there. Ailsa and Marek, thank you very much for your time. That’s all we have time for today, I’m afraid. I hope what you’ve heard has whet your appetite for all things biotech. A final piece of housekeeping, please complete the feedback survey as we’re always keen to improve what we do. Thank you so much to Ailsa and Marek for joining us today. Look out for more of our investment trust programmes, but in the meantime, goodbye and happy investing.