Biotech shares have seen better days. The growth phase between the end of the financial crisis in 2009 and the height of the corona wave in 2021 came to a halt in Q4 2021. The important NASDAQ Biotec index corrected by up to 20% until the end of January. The ERSTE STOCK BIOTEC fund has been unable to defy this development. We had a chat with the fund manager Harald Kober about the reasons of the decline and the perspectives of the biotech sector in 2022 and beyond.
Corona and Omicron are topics that seem to be everywhere, and biotech shares are undergoing a massive correction. How does this add up?
As far as the most recent developments are concerned, we should not get carried away. We can look back on an extremely long-lived upward trend over the past ten years, as a result of which ERSTE STOCK BIOTEC has recorded an annual increase of 11.5% even after accounting for the recent corrections (source: Refinitiv Eikon Datastream, 8 February, 2022). Taking into consideration the entire life of the fund to date from its launch 22 years ago, it has gained more than 7% per year. This includes the bursting of the technology bubble at the beginning of the 2000s, the 2008 financial crisis, and the 2020 crash. An investor who put EUR 5,000 into ERSTE STOCK BIOTEC at the launch of the fund for example currently has more than EUR 23,000 in her or his account (exclusive of fees and costs; source: fund calculator, www.erste-am.at). So, we are talking about a factor of 4x for the capital invested. To answer your question: shares that have increased by such a substantial degree may occasionally undergo a correction. This is healthy, and it is how stock exchanges work. Also, the environment changed over the year of 2021.
Why has the fund deviated so strongly from the biotech index in the past two years?
Let me preamble my response by saying that the fund, while using a benchmark for reference, does pursue an active investment policy and can therefore deviate from the index. We were sceptical about the valuation of the vaccine companies, therefore did not weight them in line with the benchmark and were thus not able to benefit from the excessive price spikes. As a result, we lost out on a massive amount of performance. But from August 2021 onwards, data about the effectiveness of a corona tablet were being released, which triggered a correction in vaccine shares, and the fund was able to close the gap to the benchmark. In addition, some of the companies in our portfolios were having negative studies published, which led to a massive sell-off.
As for the environment, what do you mean?
The concern about inflation has superseded the question of how the economy and employment would develop during and after the pandemic. If you have a risk-free interest rate below or around zero while prices are increasing by 5% or more, this discrepancy will not remain without consequences. The changes in interest rate expectations are therefore what is burdening the market. As a result, the 10Y US Treasury yields have increased drastically already, and the consensus expects the first interest rate increase for 2022 Higher interest rates lead to higher financing costs for companies, which eats into profits, especially for growth companies in the biotech industry.
Has the risk of failure increased?
We have seen many IPOs in recent years. In 2021, biotech IPOs accounted for a record inflow of USD 15bn, which created a situation where many small companies with only pre-clinical products were valued at around USD 1bn. They were punished hard by the market in the second half of 2021, which creates a negative image. The truth is, biotech companies in the development stage of one single product have always been subject to a variety of risks. It takes years for a drug to make it to the clinical trial phase, and still the FDA may put a last-minute halt to all the efforts. These risks had moved out of focus in the growth phase. Now it is back to the “real numbers”. What we can say though, and that is positive news for investors thinking about investing in biotech companies, is this: from my point of view, a lot of pessimism is priced into the current share prices. For investors with a long-term horizon, the price levels are attractive.
What do you think about the situation of the listed biotech companies, and what are the prospects of rising sales in the coming years?
The recent, broad sell-off has taken the valuations of biotech companies to relatively attractive levels. A triple-digit number of companies listed at the stock exchange is even traded below their book value. Even though the conditions have changed, the growth prospects are positive. In the coming five years, sales from drugs developed in the labs of biotech companies should rise by 70% (please see the chart below).
For ERSTE STOCK BIOTEC, we rely on companies with larger market capitalisation, solid profit development, and positive free cash flows, e.g. Amgen, Gilead Sciences, Regeneron, Vertex, and Biogen, to name but the five biggest ones of the portfolio. We are convinced they have a promising future ahead.
Where do you think will the growth be coming from in the years ahead for biotech shares? What role will corona play with regard to the pipeline?
I have to clearly point out that we are somewhat sceptical about growth derived exclusively from overcoming the corona virus and from the development of vaccines. While this left us in a somewhat disadvantageous position relative to the sector index, NASDAQ Biotec, in 2020, we have now seen some corona-reliant shares fall by more than 50%; so, from that angle, we have come out on top.
The recent broad-based sell-off has left biotech company valuations relatively cheap.
Harald Kober, fund manager ERSTE STOCK BIOTEC
© picture: Erste AM
The pandemic will likely be part of our lives for a little while longer then?
It is difficult to say how long the pandemic will last and whether we will be on the other side of this thing within half a year, a year, or two years. But what we can already see, and what may also be the reason for the sell-off of vaccine producers: more and more vaccines are entering the market. In addition to the well-known ones, we should soon also see vaccines from Novavax and Valneva. The market will not be an oligopoly any longer, and it is unclear whether we will need that many vaccines in the future. According to recent news, Johnson & Johnson has temporarily suspended its corona vaccine production (source: Redaktionsnetzwerk Deutschland, 8 February, 2022). Promising data from Merck and Pfizer about drugs geared to the early treatment of patients infected with covid constitute another pillar in pandemic management.
What is the investment focus of ERSTE STOCK BIOTEC?
Once we have overcome corona, it will be back to business as usual. The entire segment of gene therapy is exciting for us. There are interesting companies with some ground-breaking R&D results, trying to strike up alliances with larger companies so as to be more broadly positioned. Another field of interest is the early detection of cancer, where companies like Ilumina, Exact Sciences, and Guardent Health have done pioneering work. The fight against lifestyle diseases such as diabetes, hepatitis, Parkinson’s disease, and Alzheimer’s will continue to drive sector growth. ERSTE STOCK BIOTEC allows for a diversified investment opportunity in the biotech sector. We assume a certain degree of risk tolerance, i.e. the readiness to sustain price movements like the recent one, and of course a long-term investment horizon. In that case, the chances of a decent return in the future are quite good.
Conclusion: Despite the most recent corrections, the attractiveness of biotechnology shares based on growth is intact. Many shares currently command an attractive valuation.
The fund employs an active investment policy. The assets are selected on a discretionary basis. The fund is oriented towards a benchmark (for licensing reasons, the specific naming of the index used is made in the prospectus (12.) or KID “Ziele und Anlagepolitik”). The composition and performance of the fund can deviate substantially or entirely in a positive or negative direction from that of the benchmark over the short term or long term. The discretionary power of the Management Company is not limited.
For further information on the sustainable focus of ERSTE STOCK BIOTEC as well as on the disclosures in accordance with the Disclosure Regulation (Regulation (EU) 2019/2088) and the Taxonomy Regulation (Regulation (EU) 2020/852), please refer to the current Prospectus. In deciding to invest in ERSTE STOCK BIOTEC, consideration should be given to any characteristics or objectives of the ERSTE STOCK BIOTEC as described in the Fund Documents.
Legal note:
Prognoses are no reliable indicator for future performance.