BB Biotech — Picking growth at good value

Bellevue believes that the public market sell-off has been overdone and the biotech sector is currently undervalued. In this environment, the team has been identifying new potential portfolio holdings as well as adding to existing holdings at attractive prices.

The investment manager highlights that 2022 was a turbulent year for the world, characterised by increasing inflation, rising interest rates, the war in Ukraine, economic slowdown in China and heightened geopolitical uncertainty. The broader stock market had a rough year in 2022, with European and US stock indices down by double-digit percentage points, driven by devaluation of high-growth, and particularly technology, stocks. The manager believes that flight from growth into value sectors and into diversified, large profitable companies was a major theme for 2022. The biotech sector also sold off in 2022. Small- and mid-cap stocks were hit hardest, while most large-cap companies have held up better in a turbulent macro environment.

Nevertheless, in Q422 the picture for the biotech sector brightened. BION’s portfolio holdings demonstrated increased activity, including clinical results and regulatory decisions announcements, licensing deals and some takeovers.

As a result of lower valuations amid the 2022 market sell-off, the BION team believes that the current volatile market provides it with attractive investment opportunities. Fundamentals in the biotech sector remain strong and the team is seeing many positive developments across BION’s portfolio of companies. The manager, Bellevue, gained timely exposure to a number of companies making clinical and commercial progress with autoimmune therapies. For example, BION had achieved a paper gain of $277.6m (as at the end of September 2022, on its now second top holding Argenx, an investment. There are currently three companies focused on autoimmune disease indications in the portfolio, including Argenx, which has further scope for growth with the immunomodulatory activity success of its drug Vyvgart.

The team remains optimistic that growth equities will come back into favour and the progress within innovative portfolio companies will continue to support BION’s performance. While higher capital costs are becoming the new reality for biotech companies, the manager notes that the industry is adapting, as platform companies with multiple product lines run hybrid models that are a mix of partnerships and fully owned assets, to keep costs under control.

Bellevue says that with M&A activity still at low levels, some opportunistic takeover activity in Q422 was focused on commercial-stage companies and, according to the manager, lifted the acquisition targets’ prices towards all-time highs thanks to the premiums offered. The investment manager anticipates more M&A deals with biotech by large pharma companies.

BION’s investment team head, Daniel Koller, believes that technology remains the basis to transform many disease areas. This also applies to the COVID-19 pandemic. He believes that from now on, the world will be balancing between the pandemic and endemic stages in terms of COVID-19. Hence the focus on vaccine development continues, given the emergence of virus mutations, which may necessitate more frequent vaccine boosters than had initially been expected. Vaccines from Moderna, BioNTech/Pfizer, Novavax and Janssen have largely been founded on biotech innovation, even when they have been developed using the capabilities of major pharma companies. Further developments in the space also led to new additions to BION’s portfolio.

Bellevue’s investment management team, headed by Dr Daniel Koller, comprises nine biotech specialists with a successful track record. The team’s academic expertise and extensive experience, its long history of collaboration and interest in all fields of medicine as well as in biochemistry and business fundamentals ensure an inspiring and constructive interdisciplinary dialogue within the team and with the board of directors as well as with external experts such as physicians and analysts.

During 2022 Bellevue strengthened the team with three new members, adding to the scientific as well as artificial intelligence (AI) and digital expertise. Dr Can Buldun, who joined the company as data scientist, was a computational scientist at Roche, focusing on data science and software solutions for next-generation antibody engineering. Dr Olivia Woolley also joined as data scientist. Previously she worked at Novartis’ technical research and development team. Prior to that she was a postdoctoral researcher at the Swiss Federal Institute of Technology (ETH), Zurich, in the area of digital epidemiology and complex networks. Dr Leonidas Georgiou, who joined as a portfolio manager, previously worked as a biotechnology VC analyst at Hadean Ventures in Norway, covering European startups in pharma, medical device, diagnostic and digital health verticals, and holds a PhD in neuroscience.

The portfolio had 31 holdings at 31 January 2023, unchanged from 31 July 2022. Eight of the top 10 holdings retained their positions during the past six months, with the top 10 concentration at 74.3% at 31 January 2023. This indicates the manager’s strong conviction in key positions, which have been in the portfolio for some time (more than three years for most). Two-thirds of the portfolio is invested in eight revenue-generating companies, four of which have shown sustained profits for many years; the remainder have strong balance sheets and the team expects them to be cash flow positive in the near future.

As shown in Exhibit 2, BION’s portfolio exposure by technology is led by the small molecule category followed by RNA, antibody and gene and cell therapy.

The team is increasingly focused on emerging technologies that could lead to novel treatment methods, with attractive therapeutic profiles and substantial economic rewards. These technologies include RNA platforms and cell and gene therapies. While the small molecule and antibody areas of biotechnology have been around the longest, the team has been finding exciting new opportunities in these areas, such as targeted oncology player Black Diamond Therapeutics in small molecules and antibody-focused Relay Therapeutics. Both companies are deploying massive computational power and machine learning to deepen the understanding of disease processes and speed up the identification and development of new treatments.

The proportion of the portfolio in large-cap companies ($30bn+) was 16.3% of the total (at end June 2022). The bulk of the portfolio consists of the $5–30bn mid-cap segment (51.2%) and small (up to $5bn market cap) companies (32.6%) (Exhibit 3). Whilst 34.5% of portfolio companies are already profitable, 45.6% are financed to break even and have at least one product on the market. 19.3% of companies have drugs at an early stage of development and a strong pipeline of new products ready to be introduced to the market.

During Q422, the investment team made no new investments, but added to existing portfolio positions. These included top 10 holding Moderna, an example of a growth story with a strong balance sheet, which has become a core portfolio holding over the last two years. Following its SARS-CoV-2 vaccine success, Moderna obtained the funds to continue developing its mRNA-based technology platform for use in many more indications. The manager retains a strong conviction in the business and added to its position as the share price weakened on the investor community’s assumption that success in its mRNA vaccine for SARS-CoV-2 would be hard to repeat.

During Q222 the team initiated a position in Celldex Therapeutics, a US company. Celldex is exciting for the team because of its most advanced clinical candidate, antibody agent barzolvolimab (CDX-0159). Barzolvolimab is the first antibody agent designed to inhibit mast cell activation, the body’s reaction that can cause allergies, angioedema and hives (urticaria). Barzolvolimab is currently in Phase II clinical trials for the treatment of chronic urticaria. If clinical trial outcomes are favourable, the drug might be approved for other skin conditions and for some gastrointestinal disorders as well.

Most portfolio additions in FY22 focused on oncology companies, such as Revolution Medicines, Fate Therapeutics, Black Diamond Therapeutics and Essa Pharma, all topped up by the team following valuation dislocations. Additions in Macrogenics and Mersana followed significant pipeline deals strengthening the companies’ balance sheets. The team added to its holding in Relay Therapeutics following positive clinical data reports for the firm’s FGFR2 asset. BION also added to its positions in Incyte and genetic medicine company Ionis (both are top 10 holdings). The investment management team took profits in Neurocrine following a rebound in sales of one of the company’s products, Ingrezza, and from Alnylam and Vertex, each trading close to their all-time high share prices.

Several holding companies have released promising clinical trial data. Esperion announced positive cardiovascular outcomes for its drug Nexletol. Moderna announced that its novel mRNA vaccines achieved strong neutralising antibody titers against multiple Omicron variants. Trial outcomes from top holding Ionis showed that treatment with bepirovirsen resulted in sustained clearance of hepatitis B surface antigen and virus. Other positive clinical trial announcements came from Arvinas, Neurocrine and Celldex Therapeutics.

Multiple BION portfolio companies also received product approvals during the past three years. Bellevie expects more approvals during 2023, including mRNA seasonal flu and RSV infection – both from Moderna, Zuranolon post parfum depression and major depressive disorder – both from Sage and Tofersen drug against lateral sclerosis from Ionis.

As shown in Exhibit 4, BION has outperformed the Nasdaq Biotechnology Index in share price terms and NAV terms in two of the last five discrete 12-month periods to 31 January (all in Swiss franc terms). The last 24 months to end-February 2023 were very challenging for the biotech sector as investors preferred to reduce exposure to a sector they perceived as risky and volatile. As a concentrated fund (31 positions), BION lagged the index during that period, but increased appetite for risk over the past few months saw BION’s NAV outperforming the index. Exhibit 5 (right-hand side) shows that BION has outperformed the index over the long term, with its share price and NAV generating annualised returns of c 17% pa and c 13% pa, respectively, over the last 10 years.

During the falling market of 2021 and 2022 investors switched to larger companies, de-risking their exposure, and BION’s focus on small and mid-sized businesses contributed to its underperformance relative to the index during the past three and five years. An additional detractor from performance in the past three and five years (ended 28 February) was top 10 holding Moderna, which suffered from the market sell-off. The investment managers retain a strong conviction in Moderna’s stock.

More recent performance has been encouraging. As the biotech market began its recovery over the last few months, BION’s share price performed close to the Nasdaq Biotechnology Index over the past one- and three-month periods (Exhibit 6). A number of portfolio companies, including the top 10 holdings Ionis Pharmaceuticals, Vertex Pharmaceuticals and Argenx (c 29% of the portfolio at 31 January 2023), two of which are growth mid-cap companies, outperformed the index.

BION is not included in the AIC’s Biotechnology & Healthcare sector owing to its primary listing being in Switzerland, but in Exhibit 7 we present it and fellow Swiss company HBM Healthcare Investments (HBMN) alongside the members of the AIC peer group, which provides a relevant comparison. Within this group there are four funds (BION, Biotech Growth Trust (BIOG), International Biotechnology Trust (IBT) and more recently launched RTW Venture (RTW)), that focus primarily on biotech stocks, and four (BB Healthcare, HBM Healthcare Investments (HBMN), Polar Capital Global Healthcare and Worldwide Healthcare Trust) that have a broader healthcare remit and generally include some biotech stocks alongside those from other sectors. The last fund, Syncona, is a venture capital/growth capital investor focusing on backing and building early-stage companies, mainly in the biotech space.

BION ranks top within nine funds over one year on the NAV TR basis. As investors began returning to the biotech sector during the second half of 2022, BION’s high-conviction portfolio of quality stocks outperformed five of nine peers. The portfolio managers trimmed a few positions at a profit and this contributed to outperformance relative to peers.

In general, the funds with a broader healthcare remit have done best in NAV total return terms over the past few years, as the biotech sector devalued faster than healthcare. Three listed biotech companies lagged the peer group average in NAV total return terms over the past three and five years. Over three and five years, BION ranks sixth and eighth, respectively, among the peers.

Long-term performance remains strong. Over 10 years BION is one of the two funds to have effectively more than tripled investors’ money, while only HBMN has surpassed BION’s stellar 311.9% NAV total return over 10 years (to end January 2023). The two funds have historically looked quite different, with HBMN having a broader remit, as well as more stocks and private companies within the portfolio.

Having historically stood at a double-digit discount to NAV until early 2016, for the last five years BION’s shares have traded at a premium on average. The move to a premium was arguably underpinned by strong investor interest in the biotech sector, buying by passive investors following index inclusion and the high distribution policy. As biotech stock valuations fell during 2021 and 2022, BION reached a record-high premium to NAV of c 40% in January 2022, and having fallen to single digits premium by Q422, has climbed back to stand at c 19.7% premium currently.