The Exchanges

Q Why don't we start with your background and your path to becoming an investor in this space?

A Sure. Well, I actually come from a long line of physicians. So my mother, my father, my grandmother, and grandfather are all physicians. So you could say that medicine runs in my blood. I got as far as applying to medical school before I realized that my true interests were really more on the investing side. I also felt that I could have a bigger impact as an investor than I could as a practicing physician. And then what's been really gratifying is that's turned out to be true. The other less well-known factor is that I really don't like the sight of blood, which makes me sometimes pass out. So, uh, I think I chose the right career path.

AI assessment note: “I got as far as applying to medical school before I realized that my true interests”

Q In what's been a really tough bear market for the space, what are you looking at to see when the tide is turning?

A Yeah, so we put out a newsletter recently that we called Green Shoots for our biotech strategy. And we have seen signs that the market for biotech stocks may have bottomed in June. And what did we look for? So one is good clinical data being rewarded by the market. And we've seen that. So we've had companies reporting positive data and the stocks going up. And then importantly, they've been able to finance on that. Some of them have been raising, you know, hundreds of millions of dollars overnight. And then in many cases, the stocks would go up after they raise money. So that is a very healthy sign. Of innovation being rewarded. The second factor that we thought would pick up is M and A activity. And why do we say that? Because if you think about the top. Major biopharmaceutical companies, many of them are facing substantial patent expirations later this decade. And in some cases they're going to be losing, you know, up to half of their revenue. And so in order to replace that, they're going to need to do business development to add new innovative products. And at the same time, you have the market that has traded down and lost 70% of its value. You have these companies that by the end of 2022 are estimated to have five hundred billion in cash on their balance sheets. And even just Pfizer alone has said that they need to make acquisitions to acquire twenty five billion dollars …

AI assessment note: “one is good clinical data being rewarded... The second factor... is M and A activity”

Q I'd love to turn to some aspects of your investment process. You've touched on some of them. How do you go about doing your research into the science and the business? But let's start with the science.

A Yeah. So I'm fortunate to lead a team of analysts that I think is really just incredible. You know, in total now we have nine senior investment professionals at the firm with more than a 125 years of experience. And when you think about the therapeutic side, I studied biochemistry as an undergrad at Harvard, and I'm the least educated member of our therapeutics team. So we have three PhDs and an MD on the team. And really the goal is to really dig in and understand the science. So we spent a lot of time, for example, reading clinical literature, attending medical conferences around the world. In the age of Zoom, that's gotten a little bit easier. We used to travel all around the world. But we're meeting with key opinion leaders in every therapeutic area from cancer to heart disease to diabetes. And we want to understand, you know, first of all, what is the current standard of care? How do the doctors practice medicine in each of these fields? What are their go-to therapies? And then what are the unmet medical needs? What are the areas where a new therapy could be beneficial? Whether it's a disease where there's nothing available or one where there are treatments available, but you could do much better for these patients. And so We spent a lot of time talking to these key opinion leaders. We've developed relationships with some of them over decades, and we're always canvassing e…

AI assessment note: “reading clinical literature, attending medical conferences around the world”

Q How do you incorporate private investments into your portfolios?

A Yeah, so we've actually been investing in private companies as part of our healthcare strategy for more than 18 years now, and we think it gives us a big advantage because we consider ourselves crossover investors. A crossover investment is one where you're investing in a private company generally within a year of when you think it can go public. And so the advantage there is a lot of the innovation in the sector comes from private companies. And we want to get an early look into those companies because some of them may be very exciting investments on their own. And as an example, you know, BioNTech, which is the company that made the first MRNA vaccine along with Pfizer, we invest in that company when it was still a private company back in 2017 when most people had never heard of MRNA. So we got a very early look into companies like that. And back then the company had a two billion market cap in 2021, it got to a hundred billion market cap. But on the other hand, you also want to get visibility into the potential disruptors because they can have an impact on your large public companies. They might be a competitive product that could be superior to the current standard of care. So getting that visibility from an early stage is extremely helpful to the entire process and having a holistic view of the whole sector. We've made money. More than two thirds of the time in those priva…

AI assessment note: “we consider ourselves crossover investors. A crossover investment is one where you're investing in a private company”

Q So almost a quarter century in this space and would love to hear your perspective on maybe where we are today in terms of the opportunity, both about the underlying business and the market for these stocks. But why don't we start with the science and the business?

A Yeah. So when I think about investing, so I started as a biotech analyst, biotech and pharma. And then in 2003, I became the assistant manager on our Healthcare fund, 2007 became the lead manager. And when I think about what we were investing in back in the late nineties, early 2000, you think about the human genome project. That was the global collaboration to sequence the first human genome that was completed back in 2000. And it created a lot of excitement. We can now sequence the human genome for the first time. The problem was that took 13 years to complete and cost three billion dollars just for one genome. When you think about that, although it generated a lot of excitement, and when I first started, biotech stocks were very in vogue, and people were excited about them, but when you think about the practical applications, there really weren't that many back then. Just took too long, it was too expensive for it to be really helpful. You know, since then, we have made dramatic progress to the point where now we can sequence a human genome literally in hours, and we can do it for hundreds of dollars. And what that means is scientists now have a much better understanding of the genetic causes of disease, and they can develop new therapies that directly target those underlying genetic defects. And so that has been a major advance. That's just really one example of the improve…

AI assessment note: “now we can sequence a human genome literally in hours, and we can do it for hundreds”

Q How does that translate into the number of positions you'll have in your portfolio?

A Yeah. So we typically, if you think about the portfolio, we're much more concentrated at the top of the portfolio. So generally the top 10 stocks are going to be, you know, 30, 35% of the portfolio. We typically don't take enormous positions in one stock. We've never taken a 10% position. In one company, you know, we want to diversify the risk throughout the portfolio. In the healthcare strategy, we're going to have a balance of the different subsectors within healthcare. So we have investments in pharmaceuticals, biotechnology, healthcare services, and medical technology. In the biotech strategy, we don't want to put all our eggs in one basket. So again, our biggest positions might be five or six percent of the portfolio. Then we end up with a fairly long tail of higher risk companies, but Those might be in the healthcare strategy, maybe 30 basis point positions. So in healthcare, we probably have about a hundred stocks in our portfolio, diversified across those four subsectors. In biotech, it's probably closer to 50 or 60 stocks just within biotech, where the higher risk names are going to be lower in the portfolio.

AI assessment note: “In healthcare, we probably have about a hundred stocks... In biotech, it's probably closer to 50”

Q So what's the other side of the 90 90 rule if the first side is that 90% of the clinical trials will fail?

A For the one out of 10 drugs that actually makes it all the way to market, then you have the commercial risk of a new product launch. And what we've found again in more than 23 years of investing in health care is that the consensus estimates from Wall Street Are wrong about 90% of the time. And those estimates can be either way too high, in which case that's a stock that you want to avoid or potentially short, or they can be way too low. So you might say, well, you have all these smart analysts on wall street analyzing these companies. How can they be wrong? 90% of the time. And I think it's a couple of factors really, you know, one, it's actually very difficult to estimate what these new product launches are going to do. If you think about it, many times you're launching a product into a disease where there's never been a treatment before, and so it's not well known, for example, how many patients really have this disease? How many of those patients have a severe enough disease that they would actually try to get a new treatment? What's the pricing going to be? Is it going to be reimbursed? Are the physicians going to use it? Are the patients going to take it? Are the patients going to continue to take it? All of those can have an impact, and so the way that That we assess it is something that we call the three P's, and that refers to the physicians, the patients, and the paye…

AI assessment note: “consensus estimates from Wall Street Are wrong about 90% of the time.”

Q And how did you get started once you knew you wanted to be an investor?

A Yeah, sure. So I studied biochemistry as an undergrad at Harvard, and I actually studied biochemistry and economics. And after I withdrew my applications from medical school, I actually went to Morgan Stanley, For the first three years of my career, this was back in 94 to 97. And so worked initially in capital markets and then in venture capital, I really got a chance to invest professionally for the first time, which was really exciting for me to do all the analysis and try to pick the stocks that are undervalued. After that, I went to business school with you and, and in business school, you know, what I found is I was coming home from class every day. And I couldn't wait to get on my computer and just start researching stocks. And I was spending more and more of my time doing that, investing in my personal portfolio. And then when I was interviewing, I probably interviewed at a hundred different firms coming out of school, really trying to exactly focus in on what I wanted to do. And really when I interviewed at what was Janice then, now Janice Henderson, I just fell in love with the place. They were investing the same way that I was. It was really a focus on long-term investments and identifying companies that were undervalued. And that was really exciting to me. I actually recommended a few stocks during my interviews that a few of them, they ended up buying and so, and th…

AI assessment note: “I actually went to Morgan Stanley, For the first three years of my career”

Q When you bring all these factors together, your analysis of the science, the business opportunity management team, how do you and your team go about making decisions about what stocks to put into your portfolios?

A So our team, we're all located, by the way, in Denver, Colorado, and where we were founded more than 40 years ago. And our team is all together. You know, we meet with each other formally at least once a week, but all of our offices are next to each other. We're in and out of each other's offices every day, multiple times a day. We're on chats constantly. If we think about the portfolio construction, it's really dependent on two key factors. The first is our conviction. So do we believe we have developed investment insight that the market doesn't appreciate? And that's really measured by the discount to intrinsic value. So this, is this a company that our view is so different than consensus that we have a much higher estimate of intrinsic value than the market, or it could be, you know, the sustainability of the company's free cash flows. It could be a number of different factors that would make a trade at a discount. But then of course that's balanced by the risk. So what is the maximum downside if we're wrong? And in the extreme case, we use a value at risk approach. And so we talked earlier about binary events. So we try to invest sometimes in these binary events where we think the probability of success is much higher than the market appreciates, but we always have to make sure we manage the downside in case we're wrong. We sometimes have had stocks that could be down 80% i…

AI assessment note: “portfolio construction, it's really dependent on two key factors. The first is our conviction”

Q As you're looking at all the activity that's happening in the private companies, as well as the public stocks, what are the kind of thematically the opportunities that you're most excited about?

A As I mentioned earlier, we're seeing incredible innovation in the sector. And so we're focused on these companies that can address high unmet medical needs. And one of those areas we're really excited about is new gene based therapies. So historically we would give a small molecule, maybe try to block a protein, but when you give a gene therapy, you have the potential with a single treatment to address an underlying genetic defect. You know, there are 7000 genetic diseases and 95% of them have no available treatment today. So we're aware of these devastating genetic diseases that can have a dramatic impact on quality of life and survival, and yet there's nothing we can do about them. But now, We know exactly which gene is defective. We know a gene gets translated into RNA, which then becomes a protein. Sometimes that protein is defective and the defective protein is causing problems. Sometimes it's missing, but we have new ways now of doing everything from replacing a defective or missing protein. So you could think about factor eight for hemophilia or replacing dystrophin for patients with muscular dystrophy. We think this is incredibly exciting, and these therapies, they're here now. So we have a gene therapy for hemophilia approved in Europe. In 23, we could have the first gene therapy for muscular dystrophy. They're also working on gene therapies essentially for sickle cell…

AI assessment note: “one of those areas we're really excited about is new gene based therapies.”

Q So you mentioned earlier that psychology can play a large role in the pricing of these companies through their volatility. How do you go about trading around positions and factoring in some understanding of the psychology of the stocks?

A Yeah, that's a good question. So I have a, a spreadsheet with every stock in our portfolio and it has, what is the current price and what do we think the company is worth? And as you know, these stocks are volatile and biotech stocks are the most volatile. And so they're constantly trading up and down for often insignificant reasons. And so what we look at is how much upside is there to our estimate of intrinsic value? And so if you have a stock that's pulling back and we think it's not for a valid reason that actually changes the value of the company, then we would be adding to that position. And similarly, sometimes your stocks become in favor and the market loves them and the companies go up. And sometimes they approach or reach our estimate of intrinsic value, in which case as it approaches our estimate of intrinsic value, we're generally trimming into that strength. And if it reaches or exceeds our estimate of intrinsic value, then we generally be selling that stock. So there's a constant rebalancing in the portfolio where we're trying to maximize the risk adjusted return potential at any time. The volatility in the market, we try to use to our advantage to add to the ones that are weak that we still like. And trim the ones that are really strong that we think are starting to approach fair value.

AI assessment note: “if you have a stock that's pulling back and we think it's not for a valid reason”

Q How do all of these scientific advances translate into commercial success for the businesses?

A Yeah, that's definitely a big part of what we do. Our framework for how we invest in the space is something we call the 90 90 rule. And what this refers to is the clinical and commercial risks of developing a new therapy. And so if you think about a product that begins human clinical testing, If you look at the industry over the last multiple decades, 90% of the products that begin human clinical testing never make it all the way to market. And so this is a very challenging industry, you know, costs about a billion dollars to develop a new therapy. And the main reason for that is because 90% of them will fail. So if you think about it as an investor, especially as a long investor, Then you're really trying to find the needle in the haystack, the one out of 10 drugs that can make it all the way to approval. And these drugs go through the different clinical stages of testing. So phase one, you're generally testing it in healthy volunteers and a small number of patients trying to establish initial safety. In phase two, that will be a somewhat larger study, maybe hundreds of patients where you're actually trying to figure out the dose response and what would be the optimal dose. And then in phase three, which is the final stage of testing called the pivotal trial, you're generally testing it in a larger number of patients, maybe hundreds or even thousands of patients trying to prov…

AI assessment note: “90% of the products that begin human clinical testing never make it all the way”