Portfolio Adviser • October 2016 • Sector Report

Biotech shares have tumbled since the summer of 2015. Has the euphoria of recent years vanished into thin air? What should we expect ahead of the US elections as persistent discussion of medicine prices could depress share prices in the healthcare sector for some time to come?

We believe the current phase is actually a breathing space before the next growth curve. The market has now passed on the effects of possible shifts in sales and profit development, reflected for example in the issue of future reimbursement in the healthcare systems.

In the short term, the drug pricing discussion will continue to keep share prices volatile. Until January 2017, when the newly elected US president will announce the future direction in each area of policy, we expect the subject to continue to potentially cause irritation.

We expect companies will react by focusing their value proposition on medical innovation, drive their R&D pipelines with clinical and regulatory milestone achievements and post strong commercial results with marketed products.

In cancer immunotherapies, in particular, the innovation cycle is moving ahead and is set to generate a large number of new products in coming years, similar to what we have seen for hepatitis C over the past years. In this field, Gilead is an example of a company with a novel product in an indication that for many patients had been incurable in the past, which resulted in the most successful drug launch ever. As exhibited by this case, it will ultimately always be the value of a medicine that will determine its price.

Criticism from the political arena is often levied at the list price and frequently ignores the fact that high growth rates are generated by volumes. New therapeutic agents make it possible to treat far more patients than before, and the final level of sales is correspondingly high.

Ultimately, any discussion about the price of a drug should revolve around its medical value or benefit. Average treatment costs for hepatitis C are lower now than they were five or 10 years ago, if the complications associated with this infectious disease sometimes that led to long periods of stationary hospital treatment are factored in.

Curative approaches could produce large cost savings for healthcare systems over the long run, but the cost of cellbased treatment options or gene therapy will be even higher than today’s biopharmaceuticals derived from antibodies and small-molecule agents.

The ongoing discussion of pricing and cost models, be it for minor indications with relatively few patients or diseases such as Alzheimer’s that afflict millions of people and have growing patient populations, will most definitely be intensified for these novel therapeutic options. One question will be who will cover these costs in the future, ie the split between private insurance plans and the government.

The profit drivers marketed by industry heavyweights such as Gilead, Amgen and Celgene have enabled these companies to attain the market value of major pharmaceutical companies. That makes it more difficult to maintain profit growth at a level above that of ‘big pharma’.

To continue achieving above-average growth, these companies will draw on the innovative strength of their in-house development pipelines and at the same time take an aggressive approach to acquisitions. The recent takeover of Medivation by Pfizer is an example of this.

The number of profitable biotech companies is steadily growing. We are maintaining our current approach of building a portfolio of a small number of core holdings plus mid and small caps with the potential to grow faster than the market.

Our primary focus continues to be on companies in their growth phase that are poised to become large caps, such as the Swiss company Actelion or US-based Juno Therapeutics.

In terms of our investment strategy, the growing number of profitable companies could mean that we will reduce the percentage share of our portfolio accounted for by large caps in the future.