Could AI “serve as a catalyst driving the biotech industry into the future”?

Post-Covid, investment companies in the Biotechnology & Healthcare sector have struggled with the average investment company in the sector down 2% over the past year and currently trading on a 12.3% discount. But over the long term the Biotechnology & Healthcare sector has performed well, with a share price total return of 165% over ten years. Could artificial intelligence (AI) act as a catalyst to help turn performance around?

The Association of Investment Companies (AIC) has gathered comments from investment company managers to find out how AI is impacting drug developments in the biotechnology sector and stimulating innovation in the healthcare sector. Managers also explain the recent headwinds for the sector but believe “fundamentally it is in the strongest position that it has been for years”.

What impact are developments in AI having on the biotech and healthcare sector?

Ailsa Craig and Marek Poszepczynski, Portfolio Managers of the International Biotechnology Trust, said: “AI has enabled innovation in the biotech sector for some time, particularly in early-stage drug discovery. As computational power has increased, biotech companies have become increasingly effective at processing large amounts of biological data and screening out bad drugs earlier on in the process than was previously possible. This has particularly improved the success rate of bringing small molecule drugs to market and in predicting certain behaviours of bigger biological molecules in areas like protein folding, accelerating the development of effective treatments.

“AI will never replace the need for rigorous human clinical trials of new therapies, but we are optimistic about the impact that the technology will have on boosting rapid biotech innovation and drug discovery. AI is still nowhere near its full potential, so we expect it to serve as a catalyst driving the biotech industry into the future.”

Gareth Powell, Head of Healthcare at Polar Capital, which manages Polar Capital Global Healthcare, said: “We expect AI to positively impact the sector in terms of automation and driving productivity which will become increasingly important considering the cost of delivery of healthcare. An example would be using AI to read patient scans faster, more accurately and cheaper. In R&D we again expect AI to provide efficiency but to not significantly impact the process of new targets which is most important when developing new innovative products. Generally, expect adoption to be slow due to regulation.”

Woody Stileman, Managing Director at RTW Investments, the investment manager of RTW Biotech Opportunities, said: “At this point, we see AI as a useful tool for drug discovery, which will undoubtedly improve clinical success rates, but not a transformational paradigm shift as some might believe. Biological systems are highly complex and uncertain: we don’t (yet) know all the rules. Computers are great when you know the rules. They are not going to replace medicinal chemists, but they will make them more efficient.”

Biotechnology & Healthcare investment companies: performance and discounts

Source: theaic.co.uk / Morningstar (to 23/06/23)

What is your outlook for the biotechnology and healthcare sectors?

Gareth Powell, Head of Healthcare at Polar Capital, which manages Polar Capital Global Healthcare, said: “Our near-term outlook is very positive, the sector has lagged this year but fundamentally it is in the strongest position that it has been for years.”

Geoff Hsu, Manager of The Biotech Growth Trust, said: “Biotech sector performance has been muted this year due to continued macro pressures, including rising interest rates in the US, general small cap underperformance, and banking system concerns with the fall of Silicon Valley Bank.

“We believe the outlook for the sector is bright because the industry’s fundamental innovation remains strong, valuations for small cap biotech are now at 20-year lows, and the FDA regulatory climate remains favourable. Catalysts for a recovery in the sector include potential interest rate reductions by the Federal Reserve in the back half of the year, continued M&A activity by large pharma companies looking to acquire innovative biotech companies, and positive clinical results for biotech drugs in development.”

Ailsa Craig and Marek Poszepczynski, Portfolio Managers of the International Biotechnology Trust, said: “The biotech sector historically goes in and out of favour, leading to exaggerated highs and lows in share prices through its investment cycle. It is true that continued post-Covid consolidation and rising interest rates have suppressed share prices over the past year.

“However, this general trend masks specific areas of opportunity, and we believe the sector is concluding its recovery phase and entering a period of fair valuations. Small-cap biotech has rallied in the last quarter, and we have seen M&A markedly increase in recent months, with Pfizer’s yet-to-be-approved $43bn acquisition of Seagen, Merck’s $11bn acquisition of Prometheus Biosciences and several acquisitions of smaller names including Chinook Therapeutics and Bellus Health highlighting the attractive valuations on offer in the sector.

“A recent uptick in IPOs – including J&J’s $3.8bn spinoff of its consumer healthcare arm Kenvue – also points to renewed confidence in biotech from investors, and the sector is now poised for an influx of capital, which is key to establishing an equilibrium in the valuation cycle.

“We also remain optimistic about biotech’s long-term prospects beyond the current cycle, with an ageing population and accelerating scientific innovation providing robust tailwinds for the market for decades to come.”

Woody Stileman, Managing Director at RTW Investments, the investment manager of RTW Biotech Opportunities, said: “From February 2021 to May 2022, the biotech sector suffered its second worst bear market ever, both in terms of magnitude and duration. At that point, sector valuations looked very attractive and, from the trough in late May 2022 to the end of January 2023, the mid and small cap Russell 2000 Biotech Index rallied over 40% on the back of some exciting clinical and commercial developments in the second half of 2022 and a gradual pick up in M&A. However, the index finished the first quarter at about -7% despite other growth proxies performing well. The Nasdaq finished the first quarter +20%. This was one of, if not the, largest quarterly divergences in performance between tech and biotech.

“There were likely three contributing factors. First, the market’s focus on AI seemed to ‘suck all of the air out of the room’ for other growth sectors. Second, the SVB debacle knocked sentiment for early-stage companies and was perceived by some to be a ‘biotech bank’. Third, whispers of a more active Federal Trade Commission (FTC) could have upset the M&A momentum that accelerated in the first part of 2023. As it turned out, the FTC did bare its teeth in May with a lawsuit to block Amgen’s $28bn buyout of Horizon, which was announced at the end of the previous year.

“Despite that, M&A has continued in the sector with several more deals being announced in May and June. Given large cap pharma’s patent cliffs in the second half of the decade, M&A is not a choice for them, it just depends on what flavour. With attractive valuations versus historical averages, booming innovation and ongoing M&A, we expect the sector to continue its recovery. The shape of the recovery will depend on some macro factors, but we believe the trend is positive.”

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1. The Association of Investment Companies (AIC) represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s vision is for closed-ended investment companies to be considered by every investor. The AIC has 348 members and the industry has total assets of approximately £265 billion.
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