A lower-risk route into innovative biotech

Investors have spent much of the past two years looking for evidence of green shoots – yet few have materialised. To some degree, this is to be expected: capital has a long history of fleeing from higher-risk industries in times of economic turmoil. The financial crisis of 2008-09 also sent biotech share prices tumbling, although they soon began to rebound.

The current bear market may yet prove more enduring. But Rod Wong, the founder and chief investment officer of RTW Biotech Opportunities (RTW), thinks there are compelling reasons for staying the course. “Innovation has never been stronger and it’s accelerating,” he says. “In 2009, you could have made a case to get out of biotech because you didn’t have this level of innovation. Now is not the time.” 

In the 15 or so years since the financial crisis, once-obscure technologies such as gene therapy and mRNA vaccines have been brought to market. The first immunotherapy drug for cancer was only approved in 2011 – and these sorts of treatments have now become standard in certain types of disease. With the valuations of tomorrow’s potential breakthrough drugmakers in the doldrums, markets have failed to appreciate these scientific breakthroughs, leaving virtually all of London’s listed biotech investment trusts trading at discounts to their net asset values (NAV). 

As of 20 November, RTW Biotech was languishing at a discount of almost 23 per cent, a figure surpassed only by Syncona’s (SYNC) 29 per cent discount. And yet the pessimism surrounding RTW looks harsh considering the fund’s recent successes. In April, Prometheus Biosciences, then the fund’s largest holding, agreed to be acquired by pharma giant Merck (US:MRK) for nearly $11bn, or a 75 per cent premium. At the start of the year, AstraZeneca (AZN) bought out another of RTW’s portfolio companies, the heart drugmaker CinCor. 

The fund’s managers, in other words, have a proven track record of picking winners in the sector. Most recently, they made a somewhat controversial bid for rival life science trust Arix Bioscience (ARIX). Under the terms of the deal, RTW has offered to buy out a 25.5 per cent share owned by activist investor Acacia Research for 143p per share. Remaining shareholders have been offered 1.4633 new RTW shares for every Arix one. At the time of the deal’s announcement, RTW said this exchange ratio valued each Arix share at 143p.

This is where things start to get contentious. On 1 November, the day of the deal’s announcement, RTW’s shares fell to 108¢, meaning the all-share option available to the three-quarters of Arix’s shareholders would only have been worth 131p. Peel Hunt, one of the takeover target’s joint brokers, resigned in objection to the terms of the deal. 

In the summer, it was reported that Arix management was considering a wind-down of the fund amid the continued biotech gloom. Peel Hunt analyst Miles Dixon said this result would have “been fairer to all shareholders”. However, in the weeks since the saga came to light, RTW’s shares have climbed back up to 115¢. While warring factions might have grabbed a few headlines, they don’t fundamentally change the investment case for RTW.

Now that Prometheus is out of the picture, the trust’s largest holding is Rocket Pharmaceuticals (US:RCKT), a developer of gene therapies for rare diseases. Set up by RTW in 2015, the company’s share price has shot up by more than 30 per cent in the past month on positive newsflow. In September, it was revealed that the US Food and Drug Administration (FDA) had greenlit a phase II trial of Rocket’s potential treatment for Danon disease, a deadly inherited heart condition. The approval effectively means the drug is one step closer to being commercially available. 

RTW’s other core positions include Immunocore (US:IMCR), an Oxford University spin-off that makes drugs based on T-cell receptor technology. Put simply, these novel therapies are designed to weaponise the body’s own immune cells to fight cancer. Almost 9 per cent of the fund’s NAV comes from its stake in Jixing, a privately held firm aiming to bring cutting-edge therapies to patients in China. As of 31 October, just under a quarter of RTW’s assets were in private hands, while 60 per cent were publicly listed. The remainder consists of a mix of royalties and cash holdings.

Two of RTW’s portfolio companies, Cargo Therapeutics (US:CRGX) and Apogee Therapeutics (US:APGE) floated in New York in recent months. Although it might seem strange to go public at a time of such low investor enthusiasm, Wong says that this was the only way to access the capital that both companies needed for growth. Cargo, which is developing a treatment for lymphoma, raised $300mn from investors after its drug showed a complete response of 53 per cent in a clinical trial.

“Now they need the money to scale up manufacturing, grow the team and execute on clinical trials to registration,” notes Wong. “Given how compelling the data are, that could be within two years. That’s a public markets thing.” Over the course of this year, RTW itself has been trying to boost its own reputation among public investors. It changed its name in July (from RTW Ventures) to reflect what it calls its “full lifecycle approach to biotech”. The fund’s managers are also keen to emphasise that it’s not solely focused on the high-risk world of early-stage biotech.

“We’ve always been asset-driven, so you have to at least have a development candidate,” Wong says of the trust’s strategy. “It doesn’t have to be in late-stage clinical trials, but you do have to have an asset we can analyse and say: this has a reasonable probability of success.” For more generalist retail investors without medical expertise, biotech-focused investment trusts are a lower-risk way to gain exposure to the sector. At least in theory, fund managers with expertise in cutting-edge science are better placed to make investment decisions in this field than a novice. 

The best sector-focused funds are also diversified, meaning that if one element of the portfolio suffers, others should be able to balance it out. In RTW’s case, stability is provided by its royalty business, which grants it quarterly income after one of its companies launches a drug. Still, the fund has more private holdings than its least-discounted rival, the Biotech Growth Trust (BIOG), which reports that only 5 per cent of its assets are unquoted.

It’s possible that the perception of RTW Biotech as a risky venture capital outfit has contributed to its current discount. But the recent listings and acquisitions of portfolio companies should assuage some of these concerns. In our view, RTW’s discount is an overreaction driven by a broader pessimism around biotech. While the current bear market has been value-destructive for many investors, it can’t last forever – and demand for more targeted and effective medicines isn’t going anywhere.