Biotech outlook promising for ETF investors

Potential for continuing outperformance

Despite some volatility along the way, biotechnology stocks have significantly outperformed the S&P 500 Index over the past couple years, a trend that began in earnest after the surprise results of the 2016 U.S. election. Since then (11/8/2016 – 1/31/2019), the NYSE Arca Biotechnology Index has posted a cumulative return of 69.81%, outperforming the S&P 500 Index by 29.56%.

Here are some of the trends in the biotechnology sector that may contribute to continued outperformance moving forward.

Regulatory environment still favourable

Government regulation can have a significant impact on the biotechnology industry. Fortunately for investors, the current legislative and regulatory environment appears to be a tailwind for biotechnology stocks. The passage of the U.S. 21st Century Cures Act in 2016 was aimed at promoting innovation and improving patient care, in part by streamlining the FDA’s drug and device approval processes. Since the law was passed, the FDA has announced several important changes to expedite approvals and apply its oversight more efficiently. In June 2018, the FDA announced an overhaul of the Center for Drug Evaluation and Research (CDER) that would increase the number of drug review divisions from 19 to 30. In January 2019, the FDA announced plans to add 50 more clinical reviewers for cell and gene therapy products, an area of significant scientific research and advancement.

The results of the agency’s efforts can be seen in the number of drug and device approvals. In 2018 the FDA approved a record 59 new drugs, well above the 10-year average of 36.* Novel medical device approvals reached a record high as well with 106, surpassing the 99 approved in 2017.

Innovation continues

Innovation in the biotechnology industry is accelerating, highlighted by advances in cutting-edge gene and cell therapies for cancer treatment. The first gene therapy treatment was approved by the FDA in August 2017. Since then, 15 other gene and cell therapies have been approved. The pipeline is robust too, with the FDA noting a large increase in the number of gene and cell therapy investigational new drug (IND) applications, and projecting to receive more than 200 applications annually by 2020.

M&A activity accelerating

Merger and acquisition (M&A) activity has long been a catalyst for investor returns in biotechnology, and today is no different. In 2018, there were 10 M&A deals targeting public companies worth over $1 billion, at a combined value of $122 billion.* For comparison, there were just 2.7 deals per year, averaging $19 billion, over the prior 10 years.

M&A activity has been quite lucrative for investors in stocks that have been acquired, with premiums averaging 69% over that stretch. And the level of deal activity doesn’t appear to be slowing. Two deals with a combined value of over $95 billion were announced in the first month of 2019, including the $89 billion purchase of Celgene Corp by Bristol-Myers Squibb.

With large pharmaceutical and biotechnology companies holding ample cash on their balance sheets, seeking ways to replace lost revenue from recent and upcoming patent expirations, we expect more strategic acquisitions in the industry ahead.

In Canada, ETFs provide a good way to participate in sector opportunities. The benefits of transparency, liquidity, ease of buying and selling, and low cost make ETFs an important tool for investors.

* Source: Bloomberg. There is no assurance these trends will continue.

Karl Cheong, CFA, is Head of Distribution, Canada, at FT Portfolios Canada Co.

Notes and Disclaimer

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