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BB Biotech’s Head of Investment Management Daniel Koller on growth, value and innovation in biotech

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Focus is a publication that brings you face to face with a selection of the most in-demand asset managers in the UK and across Europe. This month’s edition features BB Biotech, one of the largest biotech investors in Europe. A Q&A with Head of Investment Management Daniel Koller reveals how innovation in medicine is offering investment opportunities. Director of Investor Relations at the group, Claude Mikkelsen, meanwhile, offers insight into BB Biotech’s investment strategy and how a combination of growth and dividend income can produce favourable investment returns.

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Q&A: Daniel Koller, Head of Investment Management

Biotechnology, the innovation powerhouse in medicine

For all of us, health is our most valuable asset. For investors, biotechnology can be an exceedingly lucrative market, with its full potential only just unfolding.

Given that drug development programmes are lengthy and clinical setbacks common, how should investors approach this environment?

What is the sector outlook for 2017 and beyond, are the fundamentals still strong?

Where are you seeing the best valuations in the market?

How has M&A activity in the last 24 months affected the biotech sector?

Trump has recently pledged to speed up drug approvals. How will this impact the sector (both for investors and end consumers)?

The biotech sector has seen double-digit market growth in Q1 this year thanks to structural trends playing out across healthcare systems. BB Biotech AG offers diversified exposure to this market along with over 20 years of investment experience and a track record of outperformance against benchmark indices. In this wide ranging interview Daniel Koller discusses sector growth, innovation and the attractive valuations of fast growing companies. Over the last five to ten years, we have seen compelling returns, but we have also experienced high levels of risk and volatility, which has had an impact on portfolios and individual investments, albeit in different ways. If you assess risk at the individual level, you have to recognise that different medical indications represent different risks. Many investors assess risk depending on how far advanced the clinical testing programme is. Often, investors will consider the risk with regard to the average historical industry probability. We believe this to be a dangerous approach; especially in fields such as haematology or anti-infectives where we can assess early on whether the data will hold up or not. The question then turns to safety and combinability with other drugs. You have to dissect which disease areas the companies are experienced in. When a portfolio is created, risk is a key consideration on how that portfolio is constructed. This is why a portfolio is preferable to investing in an individual stock. It isn’t President Trump who will set the agenda for drug approvals, it’s the FDA. That is good news. Trump’s rhetoric about cutting the length of time it takes to win regulatory approval for new medicines sounds great in theory, but it would actually mean the end consumer – the patient – will face higher risks. What we have seen already from the FDA regarding the diseases areas with more severe outcomes (e.g. oncology or many rare genetic diseases) will go through their first patient approvals in four or five years. Although that is record setting time, it’s on selective indications where you need a very controlled patient population. If we look at drugs at the other end of the scale that will go to hundreds of thousands of patients – diabetes medicine, for example – I would actually be very surprised if the timelines reduce and the safety hurdles come down. The sector has suffered substantial fund outflows in the last 15 to 18 months. M&A has always provided a short-term bump in terms of providing specialist funds with a lot of cash but then it has to be redeployed, and we still see hefty acquisition premiums in the market. In the last two or three years we have seen much more consolidation in the sector. It has become more common that big players in the sector will take out small- or mid-cap players. The number of companies that want to acquire is increasing; many of the small- and mid-cap companies are on the radar for potential acquisition. So M&A could accelerate as soon as the political clouds shift. We still think small- and mid-cap businesses are offering attractive opportunities. Where fund flows have been negative, these stocks have not performed well. Over that period many of these companies had very strong balance sheets. Small- and mid-cap businesses have now been developing various assets of their own. In many cases these assets are either close to approval, close to launch or in the midst of a launch. Valuations, however, are still substantially suppressed, as in the small- and mid-cap field specialist funds currently exist almost by themselves. In comparison, big pharma and large cap biotech companies, who conduct share repurchase programmes and are measured on simple metrics such a PE-multiples, are owned by different (more generalist) investors. We still find the biggest upside potential in the small- and mid-cap market but they obviously come with the highest volatility, and therefore the highest individual risks. Yes. We have traded strongly in the first quarter but more importantly we maintain that product approvals will accelerate. At BB Biotech, we think R&D productivity will keep pace; approval numbers will hold up; and we still see depressed valuations at lows for the large caps. So the fundamentals are all lined up to the upside. We will have to contend in the short-term with continued volatility given the new plans for healthcare reform. President Trump and the legislators will have an interesting few months ahead of them in determining how radically they change health care policies. But in the medium to long-term, we are very optimistic for the sector. The industry’s transparency is always up for discussion in terms of who is paying, and at what cost, but if transparency increases, biotech will benefit considerably. I say this because in almost all cases, the products offer substantial medical benefit for the patient, society and the healthcare sector at large.

BB Biotech AG 24-year performance (in USD)

analysis

To deliver their business strategies biotech companies require significant capital that is both long-term and often USD-based. As expected BB Biotech AG has a positive sensitivity to the USD trade weighted index which illustrates how the trust benefits from business cycles with a strengthening US currency. When looking at global interest rates it is expected that the BB Biotech AG trust would suffer from headwinds to increasing global short-term rates. For any economy there is often a delicate balance between too much inflation and not enough. As inflation increases it has a detrimental effect on fixed interest investments for holders, but it can also be an early sign of economic recovery. Pockets of inflation have returned which is a welcome sign. The current year-on-year trend is still falling but that will change in direction if inflation holds globally. As such, the BB Biotech AG trust is expected to see a positive contribution to its performance if global inflation increases.

Attractive payout policy

Most stocks with high dividend yields are clustered in the more defensive parts of the stock market where the fundamental growth rates are low. In distinction to these stocks, BB Biotech is focused on promising, future-oriented markets with strong growth prospects – and it offers a 5% dividend yield as well. On top of this BB Biotech is also conducting continuous share buybacks up to 5% of share capital per annum.

How BB Biotech invests

BB Biotech invests in fast-growing biotechnology companies that are developing and marketing innovative drugs. It focuses on biotech companies whose products address areas of significant unmet medical needs and that are generating above-average sales and profit growth. The focus is primarily on profitable mid- and large-cap companies as well as smaller biotech companies with attractive R&D pipelines, preferably with products already in the final stages of clinical development. A total double digit return p.a. over a medium- to longer-term investment horizon is targeted.

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FUND SNAPSHOT

BB Biotech AG trust

Source: PureGroup As at 31 March 2017

Growth drivers in biotech

Investing in a global topic

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Lyxor’s gilt and index-linked gilt ETFs ongoing charges per year

As at 28 February 2017

At the beginning of 2016 biotech equities were unable to withstand the downward pressure that put financial markets around the globe into correction territory. More recently, movements in the US to repeal and replace the Affordable Care Act have led to some short-term volatility.

Yet this has not blunted the overall positive uptrend in the broad healthcare equity markets. The MSCI World Healthcare Index closed the first quarter with a plus of 8.7% in USD, and the Nasdaq Biotech Index outperformed with a double-digit gain of 10.8% in USD for the same period. BB Biotech has weathered the past investment year and all the volatility comparatively well. This positive performance has continued into 2017. The total return for BB Biotech’s share price in Q1 this year was 7.4% in CHF and 7.0% in EUR. The portfolio showed an overall gain of 12.6% in CHF, 12.3% in EUR and 14.5% in USD. “Despite the uncertainty on the political front and the macroeconomic unknowns, the sector’s fundamentals have remained very solid,” says Claude Mikkelsen, Investor Relations Director at the group. “Regulatory approvals of biotech drugs, successful clinical trials involving new treatment approaches and ongoing takeover activity suggest that the biotech industry will continue to deliver double-digit growth in the future.” An ageing global population will remain a key factor in driving innovation in medicine and keeping the rate of healthcare spending in industrialised and emerging market countries at a higher level than the corresponding rate of GDP expansion. “Every second drug approved today has originated from a biotechnology laboratory,” says Mikkelsen. “Attractive returns beckon and long-term investors can capture this structural growth potential by investing with BB Biotech. On top of the growth story, investors get a dividend yield of 5% per annum. Our investment trust places in the highest yielding quartile of stocks compared to FTSE stocks – and in the broader Stoxx Europe 600 index, of which BB Biotech is a member, we rank among the top 100 dividend-yielding stocks. Ongoing share buyback programmes of up to 5% of share capital also generate value for BB Biotech shareholders. With its shareholder distributions policy adopted in 2013, the group aims to generate a return of up to 10% p.a. for its shareholders. Product approvals are set to accelerate over the next 12-18 months. The launch of Spinraza for SMA patients, Niraparib for ovarian cancer patients and targeted cell-based cancer therapies are key examples in BB Biotech’s portfolio. Merger and acquisition activities are also expected to affect the shorter-term performance of the sector. The Actelion takeover by Johnson & Johnson will generate around US$270m in cash for BB Biotech’s portfolio in the second quarter, and selective increases in existing undervalued shareholdings will also be considered by the investment management team. Further discussion and initiatives concerning drug pricing and value-based approaches are expected over the coming year. This could continue to weigh on investor sentiment, but the related risk appears to be priced in for the medium term at least. The repeal and reworking of the Affordable Care Act will remain on the agenda, and there may be choppy reactions to possible drug price controls or moderation in the US. Despite these transitional events, Mikkelsen remains convinced that the sector will further demonstrate its strength as a source of innovation. With biotechnology valuations at very attractive levels, more acquisitions by large players are expected. BB Biotech’s long-standing criteria for selecting investments in companies delivering drugs for unmet medical needs, together with an increasing focus on pharmacoeconomic-driven price policies, are grounds for confidence in the portfolio investments.

Dr. Daniel Koller Head of Investment Management

Claude Mikkelsen Investor Relations Director

Claude has been Director of Investor Relations at BB Biotech since 2012. He has a Master’s degree in Economy and Law from Aalborg University, Denmark, and an MBA from INSEAD, France. Daniel joined BB Biotech’s Investment Management Team in 2004, becoming Investment Director in 2010. He has a Master’s degree in Biochemistry and a Phd in Biotechnology from the Swiss Federal Institute of Technology (ETH) Zurich.

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