When I look back at my columns over the past few years, one obvious disappointment stands out: biotech. I’ve been a fan – and have invested heavily on my own account – for many years for all the usual reasons trotted out by fund managers in the space.

Lists of thematic drivers and tailwinds matter not a jot when investors decide they don’t like a sector or theme, as has happened with biotech. Anyone can draw up a list of ‘headwinds’, which include rising interest rates, useless launches that were thoroughly mispriced, greater regulatory-driven cost pressures, and the simple fact it takes many years for a smaller biotech company to nurse its product to market.

Sadly, too many young businesses don’t end up having cash to get to the end of the runway, and the inevitable fall from grace happens.

Bottom of the bear market

Now with the backstory out of the way, I’m completely willing to accept this time it may not be different but there is a chance we might have seen the bottom of the biotech bear market – though I did say that last year and I was wrong then. 

As bear markets go, the biotech sector has endured one of the worst, falling about 40% from its peak in August 2021 to trough in June 2022. But there are signs the recent rally could endure. The Nasdaq Biotech index is up about 20% since late October’s low, while the S&P Biotechnology Select Industry index, which tracks small- and mid-cap stocks, has risen 35%. The chart below shows the price of the biggest UK-listed biotech index tracker fund from Invesco. I have also included 20-day (in green) and 200-day (in blue) moving averages. From a technical perspective, the signs are promising.

It’s not just charts that suggest things might be looking up. Initial public offerings (IPOs) are crucial for boosting confidence, and the flotation pipeline has restarted again as venture capitalists look for an exit on the money they invested five years ago.

According to the Financial Times and Pitchbook, IPO funding for biotech companies in 2023 dropped to $11.6bn (£9.18bn) – the lowest fundraising total for first-time funds since 2013. In comparison, $25.6bn was raised in 2022. By last month, the pipeline was open again, with the FT reporting that in the 10 days up to 2 February, four biotech companies raised $800m. Shares in US-based CG Oncology jumped 96% to close at $37.17 on their first day of trading in late January, while ArriVent Biopharma raised $175m at launch in the same week.

Looking at fundraising more generally for drug developers, a total of $6.2bn came into the sector in January, according to data from Jefferies. That marked the largest total since February 2021, although most of the recent fundraising, $5.6bn, was raised by already-listed companies. That reinforces a central point – investors’ tolerance for early-stage businesses is still limited and most money raised is for those that are relatively advanced.

Strong tailwinds

This increased IPO activity has also been echoed in broader merger and acquisition (M&A) activity. According to Geoffrey Hsu, co-manager of Biotech Growth (BIOG ), ‘pharmaceutical companies dealing with significant patent expirations on key products in the second half of this decade have been aggressively buying biotech companies to acquire products to fill their future revenue gaps’.

‘There were nine M&A transactions announced in the fourth quarter of 2023 totalling $47bn, and the first quarter of 2024 is off to an equally strong start with five transactions announced totalling $12bn in value,’he said.

That message is echoed by Swiss-listed BB Biotech (BION.SWX), which believes capital markets reopened in the last months of 2023 to large-cap biopharma companies. It observed: ‘In contrast to the broad investor base favouring large caps, many of them continue to bolster their pipeline and technology access by acquiring smaller to mid-cap companies.

‘The recently accelerated take-over activity combined with an improved capital market allowing companies to raise working capital again supports both the sector but as well BB Biotech’s view that valuations are highly attractive and the innovation power to reside in the smaller and mid-cap segment.’

One industry news service reports recent IPOs and follow-on financings have seen mutual funds participate in a more meaningful way, suggesting generalist funds are becoming more interested in biotech again.

Another bright sign is that venture capital funds looking to invest in earlier-stage private biotech firms have been very active in recent months after a long lull. Arch Venture Partners, a leading player in the biotech ecosystem, recently raised a new $3bn fund, its 13th to date.

Those closing fundraising in the second half of last year also included firms such as Westlake Village BioPartners, Bioluminescence Ventures, Pivotal Life Sciences, Abingworth and Yosemite. Combined, those six funds alone have more than $6bn to deploy into new investments. Even Goldman Sachs has entered the market with a blockbuster biotech fundraising.

Size matters

All of this, of course, is music to the ears of the large, listed biotech funds. BB Biotech for instance has seen its share price increase by just under 28% in the past three months – and by 11% in January alone.

Biotech Growth is only marginally behind those numbers. Both of these hugely popular funds have a large mid- to small-cap exposure, which has shown the strongest positive momentum.

Funds with a more large-cap feel to them such as International Biotechnology (IBT ) – on a 9% discount and favoured by analysts at Deutsche Numis – have also turned in decent numbers so far. This fund is now managed out of Schroders by Ailsa Craig and Marek Poszepczynski and is up just under 15% over the last three months and almost 3% over the last month. Citywire is broadcasting an event with them next Tuesday at 11am. Register here if you’re interested.

By contrast, the biggest laggards to date have been the listed venture capital biotech funds, specifically RTW Biotech Opportunities (RTW ) and Syncona (SYNC ). The UK-based Syncona in particular has had a terrible time, with its share price down 53% over the last three years and 30% over the last year. Its shares have even fallen more than 7% over the last three months.

All that red ink has been reflected in Syncona’s discount widening from 6% at the start of 2023, to 36% currently. But Syncona has, nevertheless, been active in portfolio terms.

In November, for instance, it agreed terms with portfolio business Freeline Therapeutics to buy back the shares it didn’t already own, giving Freeline a valuation of $28.3m, a 50% premium to the small firm’s pre-deal share price. Syncona felt the market wasn’t properly valuing the business and that it could make more money by taking the firm private.

Another portfolio company, Autolus, has also announced a strategic collaboration, with Germany’s BioNTech, to advance its CART cell therapy programmes towards commercialisation. In parallel, Autolus announced a $350m equity placement to strengthen its balance sheet as it moves towards launching new products.

RTW Biotech Opportunities, a London-listed though US-based venture capitalist, has also been busy in the last few months. It’s just wrapped up a highly controversial takeover of rival life sciences investor Arix, which involved a big cash payout to a US investor alongside rolling the rest of the shareholder base into the enlarged RTW vehicle.

In terms of net asset value (NAV), performance improved, with NAV up about 20% in dollar terms in the fourth quarter and 2.5% in January, with portfolio businesses such as Rocket Pharmaceuticals increasing in value by more than 50%.

There were also several IPOs from portfolio businesses, such as Cargo Therapeutics and Kyverna, plus news of a collaboration between Bayer and portfolio business JiXing. RTW’s manager Rod Wong certainly seems more upbeat now the Arix deal has delivered a useful cash injection, reckoning that ‘the sector is back in a healthy place’.

‘Interest rates are no longer rising, pharma companies paid an average premium of 70% last year for successful deals, and the first couple of high-quality IPOs have traded up significantly this year,’ he said.

‘Most importantly, however, we see considerable opportunities to invest in companies with potential blockbuster products selling for attractive prices. In terms of specific areas we are finding interesting at the moment, we’re particularly excited about the continued progress in metabolic disease and the progress being made in cancer with emerging new modalities.’

Sentiment still on the mend

So, is the bear market over? The hard numbers tentatively point to the bear market troughing last year but that doesn’t necessarily mean all the firms in the sector are out of the woods yet. There’s a long tail of investors nursing long-term losses from the past three years who might be tempted to sell into any short-term rally.

I’m less convinced that sentiment has improved for most micro-cap and smaller biotech stocks, especially those outside the US, particularly here in the UK.

Andrew Craig at Conviction Life Sciences got very close last year to listing a UK fund that invested in these non-US tiddlers and he reckons sentiment is still depressed. According to Craig, the UK smaller-cap biotech space is especially vulnerable not only to worries about financing but also to a broader set of liquidity concerns for UK micro and small caps generally.

‘A succession of poor policy choices and regulatory changes with dire unintended consequences have not far off eviscerated the UK smaller company equity market in the last couple of decades,’ he said. ‘Life sciences companies have been particularly challenged. 

‘In a difficult market for smaller companies overall, and with capital depth shrinking year by year, loss-making, earlier-stage businesses requiring specialist knowledge have struggled to attract investment from the generalist investors running smaller company funds.’

The fund managers of International Biotech Trust will be in the Citywire studio at 11am on Tuesday 27 February to talk about the improved prospects of the sector. Register here!

Any opinions expressed by Citywire, its staff or columnists do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account people’s personal circumstances.