Is biotech back?

Who wouldn’t want to back the companies responsible for curing the ills of the planet if they could be confident of making money in the process? However, the problem for investors in the biotechnology industry is that in recent years, even making a positive return has been a struggle. Indices of biotech shares finished both 2021 and 2022 in negative territory and almost suffered the same fate in 2023, only saved by an end-of-year rally.

Nevertheless, biotechnology is now attracting interest from investors worldwide once more. That end-of-year rally has continued into 2024, with the S&P Biotechnology Index climbing 12% in the first two months of the year alone.

In part, this bounce back reflects expectations of interest rate reductions to come – crucial to biotech companies’ ability to raise money at affordable prices to fund their research. But it also suggests that the market correction seen following the boom year of 2020, when the Covid-19 pandemic drove enthusiasm for all things health and biotech, may have been overdone. By last October, more than 200 biotech companies worldwide were valued at less than the cash they had in the bank.

The value proposition for biotech is pretty compelling. The global population continues to grow – and to age – driving huge demand for treatments for illness and disease. Plus, new technologies are spurring exciting new advances – in areas such as gene therapy and immunotherapy, for example, as well as in techniques for discovery, where artificial intelligence is increasingly playing a role.

The value proposition for biotech is pretty compelling. The global population continues to grow – and to age – driving huge demand for treatments for illness and disease. Plus, new technologies are spurring exciting new advances – in areas such as gene therapy and immunotherapy, for example, as well as in techniques for discovery, where artificial intelligence is increasingly playing a role.

For investors, this offers huge potential. “Biotechnology is a high-growth market which is forecast to increase by 14% each year, from $1.5 trillion in 2023 to $3.9 trillion in 2030, according to Grand View,” points out the investment trust team at analyst Kepler in a recent note. “Another tailwind to returns is the high level of M&A activity in the biotech sector.” Successful companies get bought at high prices by pharmaceutical giants desperate to maintain the flow of new treatments.

That said, picking winners in biotech is difficult, particularly for individual investors who lack the skills to assess the complex science that the industry pursues. Unless you have specialist knowledge, it’s very difficult to assess the claims made by biotech businesses about the efficacy and potential of their inventions.

For that reason, if you’re confident in the long-term potential of biotech shares, it makes sense to invest through a professionally managed collective investment fund, rather than in individual biotech companies. You get the expertise of a fund manager who is qualified to assess such businesses on your behalf. You’ll also be investing in a diversified portfolio of biotech businesses, mitigating the risks posed by individual companies in the sector.

In which case, the AIC Biotechnology & Healthcare sector is a good place to start the hunt, with eight funds to choose from (though some of them aren’t pure biotech plays). There are a number of open-ended funds that also offer exposure to biotech, but investment trusts have certain advantages in this area.

First, there’s the structure. In an open-ended fund, the size of the fund expands and contracts as investors move money in and out. If too many investors want out, the manager may have to sell investments to pay them. That’s more likely in the biotech sector, which often sees big swings in investor sentiment, than in other areas. It’s also more problematic, because biotech companies are often small and sometimes privately owned; this can make it difficult for managers to sell them quickly and at an acceptable price.

Investment trusts, by contrast, issue shares that offer exposure to the underlying assets in the fund – they are closed-ended funds that remain the same size as investors buy and sell those shares. That makes them a better fit for potential illiquid investments such as biotech businesses.

The second advantage of investment trusts will interest investors who are seeking income. Biotech companies often don’t generate income, because they’re early-stage companies that are still on the path to profitable growth. However, as Kepler points out, investment trusts, unlike other funds, can use capital reserves to pay dividends. “This can provide income for investors in a sector [such as biotechnology] which is more growth than income-focused,” it argues.

None of which is to suggest that now is the moment to plunge into the biotech sector – the jury remains out on whether the recovery of the past few months is sustainable, particularly given the uncertain economic outlook. But if you are excited by the prospect of investing in these innovative businesses – an undoubted force for good in our society – an investment trust is worth considering.