Two weeks ago, I struck a gloomy note on the prospects for the listed investment companies’ sector. My final warning was that broad sectors can remain in a funk for many years even if positive catalysts such as mergers and acquisitions emerge.

On that score if you’re looking for a case study of what a recent multi-year bear market can look like, then why not start with the biotech sector? I’ve long championed this small but vocal area as a potential recovery play but sadly, to date, there’s not been much sign of that, despite some promising signs that M&A activity is picking up.

The headline numbers are best captured by the main index in this space, the US-focused Nasdaq Biotech index, which is dominated by its four largest stocks – Amgen, Vertex, Gilead and Regeneron – which account for around 35% of the benchmark.

Although over five years this large-cap index is up 10%, over the last three years it’s down over 4% and year to date has dipped around 2%. If you thought that was bad, then take pity on its sibling, the Nasdaq US Small Cap Biotech index, which has fallen 6.5% over the last year, 22% over the last three years and 17% over the last five years.

M&A spark

The only, small, bright spot is that year-to-date the small-cap index is basically where it started. The Orbimed fund managers of Biotech Growth (BIOG ) point out that smaller company valuations are currently at near 20-year historic lows although some investors have spotted small signs of an improvement in recent months.

According to Orbimed, valuations are now below those last seen before the 2000 dotcom bust, the 2008 Great Financial Crisis and the Hilary Clinton drug pricing tweet in 2015, with around a quarter of biotech companies trading at less than the net cash on their balance sheets.

Low valuations should, in theory, spark takeovers. And it’s true that M&A is on track to be at the highest level in four years, with $93bn of deal value to 30 June, although that looks low when compared to the total of $328bn in 2019.

The good news is that some of those deals have benefited the handful of listed funds operating in this niche. The bad news though is that good news hasn’t sparked a revival in sentiment with returns more suggestive of a prolonged bear market than a recovery.

Syncona stutters

Arguably the worst-hit stock has been Syncona (SYNC ) which sits alongside RTW Biotech Opportunities (RTW ) as a focused venture capitalist backing earlier-stage businesses, although both funds also have large stakes in public, listed biotech firms.

Syncona’s shares currently trade at a yawning 34% discount to net asset value (NAV), not helped by the recent news that Novartis has decided not to proceed with the development of a key project which was the lead asset of a business sold by Syncona called Gyroscope. That has led to a £54.5m hit to Syncona, equivalent to 4.4% of NAV, as a series of payments have now been effectively written off.

Full-year 2023 numbers released in the summer weren’t that positive either, with a 4% decline in NAV for the full year, valuing the life sciences portfolio at £1.26bn or 187p per share. That NAV number wasn’t helped by a previous £51m write-down for a business called SwanBio.

Still the portfolio of seven clinical stage companies looks in decent shape, and the managers at Syncona are sticking with their strategy, investing £177m in the last financial year, adding four new companies. In total all the companies in the portfolio delivered 16 clinical read outs and between them raised £400m.

Syncona says it has a £650m capital pool to fund the rollout of the businesses and most analysts reckon it can easily meet its existing commitments for another three years at least. The key development to watch out for now is data on a treatment called obe-cel from Autolus and it’s also worth watching progress on a relatively new investment called Beacon Therapeutics.

RTW’s Rocket

Syncona’s nearest peer is RTW Biotech, formerly called RTW Venture, which also invests in a venture capital portfolio of earlier-stage businesses, although it also makes a point of investing in cheap, listed biotech stocks. RTW’s discount is only a little lower than that of Syncona which looks a bit unfair given the flow of positive news for the portfolio – that said, its shares have gained in value this year and over the last year.

Interim results to 30 June this year showed NAV per share of $1.68 which represented an increase of 9.3%, largely driven by a couple of portfolio deals: Prometheus Biosciences was taken over by Merck at a 75% premium, while Cincor was purchased by AstraZeneca at a 206% premium.

Another positive for the fund has been the recent news that Rocket Pharmaceuticals has seen a big increase in valuations following positive news of a phase two trial for a drug treating Danon disease – the regulatory green light meant resulted in Rocket launching a big share issue to kick start drug launch.  

Overall, the portfolio looks fairly diversified with 21.7% of NAV in private companies, whilst 29.5% sits in ‘public core portfolio companies’ that started off as private businesses but are now listed. Another 30.8% is invested in other public liquid biotech holdings, and currently 10% is in cash. Crucially the fund has also announced that it will be investing money in a royalty strategy targeting smaller biotech firms in need of capital to grow – typically financing a business after phase three trials have been passed.

BIOG vs IBT

Looking at the two mainstream UK-listed biotech equities funds – Biotech Growth and International Biotechnology Trust (IBT ) – both trade on respective discounts of 7.2% and 4.1% for IBT and have endured a rocky 2023 so far, underperforming the Nasdaq Biotech year to date with share price declines of14.5% and 8.5%.

In a sense the portfolio strategies for both funds explain some of that difference in returns. Biotech Growth is much more biased towards emerging, smaller biotechnology stocks which as we’ve discussed have underperformed over the last few years. That doesn’t mean that BIOG hasn’t benefitted from portfolio activity – in the last full year report, it noted that five portfolio companies have been the subject of bids including Seagen (oncology treatments) which was subject to a bid from Pfizer.

Performance in the past few years has also been undercut by investments in Chinese firms which have no been dialled back but overall if you believe the small-cap valuation argument – they are dirt cheap – then BIOG seems well positioned in an upturn.

International Biotechnology, now managed by Schroders but with the same managers, has a noticeably different investment strategy that is much less focused on smaller, early-stage businesses and more on mid-cap and established biotech firms. The portfolio is diversified by stage, split between profitable (48%), revenue growth (29%) and early-stage (23%) – in all 90% of the portfolio is in listed stocks. The largest exposure by therapeutic area is in oncology which represents just under 20% of the portfolio.

Unlike BIOG, IBT has a bigger exposure to large-cap stocks: around half the portfolio although that is lower than the Nasdaq Biotech index. The portfolio is also heavily traded – according to analysts from Numis, portfolio turnover is relatively high, currently 121% versus a five-year average of 104%). If you’re looking for a more cautious fund, then IBT is probably for you whereas BIOG’s share price might end up more volatile given the small-cap bias.

Arix review

One last mention should also go to Arix Bioscience (ARIX), another UK-listed life sciences venture firm which is close to Syncona and RTW in boasting a mixed portfolio of private and public businesses. Back in the summer this fund announced a strategic review which included the option of a tax-efficient winddown of the business. The last NAV for the fund was £1.82 or £235m which included £100m in cash. That cash is equivalent to more than two thirds of the current share price – the other £130m plus of public and private assets is effectively valued at around a two thirds discount.

Stepping back from the ins and outs of each of the funds, it’s clear that the biotech bear market is probably still in full flow. The index might have troughed yet despite the promising news on M&A activity, there doesn’t seem to have been any pronounced bounce back in positive sentiment. Biotech remains massively under owned by most mainstream investors and currently there’s no sign that’s about to change any time soon. All the long-term drivers that constantly get talked about with biotech are still in place – ageing population, increasing health spend, the genomics revolution, big data, even AI – it’s just that’s not translating into big sector outperformance, yet.

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, objectives and attitude towards risk.