Daniel Mahony, Fund Manager, Polar Capital Global Healthcare Growth & Income.
The best part of being a healthcare portfolio manager is staying at the cutting-edge of medicine. The healthcare sector is full of innovative companies that promise to cure disease, disrupt current medical practice or solve major clinical problems. Companies that deliver on their promises can provide investors with substantial returns.
Reflecting on my more successful investments, a common theme is that they certainly didn’t feel like winners at the beginning. When you buy a stock with high risk/reward you hope your evaluation of the upside potential is correct, but the potential downside risk of being wrong churns the stomach and can affect how you sleep at night.
Before investing in any small drug development company there are three important questions to ask: will the drug get approved, will doctors use it, and does the company have enough money to get the drug to market? These are easy questions that are often difficult to answer with any certainty, especially for non-specialists.
Oxford Pharmasciences is a small UK company with a drug formulation technology that masks the taste of a drug and makes it more easily digested in the stomach. The company is developing new versions of common painkillers, such as ibuprofen and naproxen, which may reduce the gastric irritation and bleeding seen with currently available versions.
When we made our investment, we faced two key risks: the company lacked capital and needed to demonstrate that their drugs could show clear differentiation. Analysis suggested there was significant commercial potential if the company was successful, but the prevailing valuation did not reflect this – the risk/reward was heavily skewed to the upside if the company could raise sufficient capital.
We participated in a fundraising for the company in 2011 at 1p per share. With the market capitalisation below £10 million, this began to address the financing issue. Over the past four years, the management team has made significant progress in the clinic and has delivered preliminary data showing that its formulations do reduce gastric irritation.
The stock is now at 12p per share (as of June 2015) and the company has a market capitalisation of £120 million. In the coming 12 months, we expect the company to sign a major licensing agreement with a larger pharmaceutical company that will validate the progress that has been made and provide a route to commercialisation.
This investment re-emphasised two lessons for us. Successful, small companies need both strong executive management and an active board – the latter were instrumental in tackling the financing risk for Oxford Pharmasciences.
A critical function of the capital markets, and a fund manager, is to allocate some capital to small, innovative companies that could have a major impact on society. Clearly, this is done with an intention to make money for clients and we balance the risk/reward of each situation very carefully.
Moreover, to make outsized returns, you need to take risk, be contrarian and back your own analysis – as Benjamin Graham famously said: “In the long run, the market is like a weighing machine.” One of the major advantages of a closed-end fund is that it is possible to be patient and make long-term investments.