The most compelling reason why investors may be re-allocating assets from pharmaceutical stocks to biotechnology stocks is that the latter have recently been offering superior returns.
By comparing the performance of a leading biotechnology mutual fund (Fidelity Select Biotechnology, which invests at least 80% of its assets in biotech companies) and a leading pharmaceutical mutual fund (Fidelity Select Pharmaceuticals, which invests at least 80% of its assets in pharmaceutical companies), one can clearly see that, while the performance of the two sectors is closely related, the biotech sector has consistently outperformed the pharmaceutical sector over the past two years (Figure 1).
Burrill & Company, a life sciences merchant bank and venture capital firm, predicts that in 2005 biotechnology stocks will outperform pharmaceutical stocks, the Nasdaq, and the Dow Jones Industrial Average.
One reason why biotechnology stocks may outperform pharmaceutical stocks is that biotechnology investors tend to take a longer-term view of the market than pharmaceutical investors. The hit-or-miss nature of the biotechnology industry attracts investors who are more risk-tolerant, and more interested in future growth, as opposed to current profits.
However, especially after so many biotechnology start-ups failed in the 2000 market down-turn, biotechnology firms are conscious of the need to find ways to reduce risks in order to attract funding.
Hence, new business models are emerging in the biotechnology industry that are geared to reducing investor risk in order to attract funding from investors who are not willing to expose themselves to the level of risk normally associated with biotechnology firms.
A joint venture is often an ideal arrangement that benefits both parties. Figure 2 illustrates the relationship between a biotechnology company and a pharmaceutical company in a hypothetical joint venture.
Venture capital funding for biotechnology in the U.S. has recently undergone a significant revival (funding in 2003 was $1.3 billion, a 32% increase over 2002), but venture capital firms are being much more cautious about where they invest their moneythey are less interested in biotechnology companies that are performing ground-breaking research, and more interested in those companies that have good prospects of bringing potential blockbuster products to market.
Hence the emergence of the NRDO model. NRDO stands for No Research, Development Only, and refers to companies that attempt to reduce the high risk of failure and long periods of unprofitability typically associated with biotechnology start-ups by eschewing drug discovery. Instead they concentrate on shepherding existing but as-yet-unapproved drugs through the clinical trial pipeline and hopefully toward FDA approval.