Biotech Stocks: High Idiosyncratic Risks, High Alpha?

A 30-year recap

May 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Biotechnology companies have the potential to change our lives dramatically
  • However, the performance of biotech stocks has been unimpressive since 1993
  • Fund managers have failed to generate alpha in the sector

INTRODUCTION

Most technological change today is an evolution rather than a revolution. Naturally, it is great to have a mobile device that allows instant access to the global knowledge depository, entertainment, shopping, and so on, but most of these innovations have been predicted decades ago by science fiction authors. Reading such novels actually makes human progress seem awfully slow.  Human colonies amongst the stars and interstellar travel still seem ages away.

Aside from building better machines to help us in work and life, changes to our bodies and genes are also frequent topics of science fiction. The progress there seems even slower.

Although the life science industry did manage to create COVID-19 vaccines in a short time period, we still suffer from cancer, tooth decay, and obesity. It is obvious that most of such conditions can be fixed with genetic modifications at some point.

Investors focused on long-term themes often include an allocation to this genetic revolution. There are plenty of broad indices that provide exposure to biotechnology or pharmaceutical stocks, as well as strategies specialized in cancer, gene editing, and Chinese biotechs (read An Anatomy of Thematic Investing).

 In this research article, we will evaluate the track record of the biotech sector in the US stock market.

PERFORMANCE OF BIOTECH STOCKS

Most of the large listed biotech companies are not known to the public, except perhaps Moderna, which was one of the earliest companies to offer a COVID-19 vaccine. The obscurity of biotech companies is partially explained by many of these having distribution agreements with the large pharmaceutical companies, which puts their own brands into the background. Furthermore, the biotech sector acts as an incubator for the pharmaceutical industry where startups with attractive drugs in development are often acquired, thus ceasing to exist as publicly traded stocks. </