Optima Health Care and Biotechnology Strategy

Compelling opportunity set for alpha generation

Hamlin Lovell
Originally published in the February | March 2020 issue

“At a time when the investment environment seems so uncertain in the short term, savvy investors know that the health care sector generally, and the biotech and therapeutics sub-sectors in particular, have tremendous potential for long-term growth,” declares Optima founder, Dixon Boardman, who also has personal experience of investing in health care stocks over the past 40 years. “Health care is the fastest growing area of the economy,” he continues, “and the FDA has become more accommodative in passing new drugs. There are also opportunities on the short side, and some managers have been active on both the long and short side as binary drug trials generate huge volatility. Over the past decade, the managers underlying our multi-manager strategy have consistently outperformed the S&P 500. We have identified five of them; often they employ doctors and PhDs to obtain extra insight.” 

Health care is a big sector, very close to technology and financials in the S&P 500 weightings, but Boardman prefers smaller managers running between $500m and $3bn, who can capitalise on opportunities in small caps – and sometimes even microcaps – where the economics can sometimes be akin to venture capital: nine firms may fail while one produces spectacular returns. The selected managers also have some scope for investing in pre-IPOs, up to a maximum of 10%.

It is better to pick managers than stocks in the health care space.

Dixon Boardman, Founder, Optima

Optima has experience of tracking top hedge fund managers’ health care stock picks, in at least one of its vehicles which uses managers’ US regulatory filings to mimic their long books, with a time lag. But Boardman has come to the conclusion that, “it is better to pick managers than stocks in the health care space”. Some of his favourite managers have little or no capacity in general but Optima has secured limited capacity for its multi-manager strategy. The Hedge Fund Journal usually discloses the names of managers, but on this occasion we are making an exception, and anonymising them, as Boardman feels that their identities are proprietary information. We have quotes below from three such managers.

Secular growth

Ageing populations, in both developed and most emerging markets, and the ability to treat hitherto uncurable conditions, are two key growth drivers. Global health care spending reached $7.724trn in 2017, and is forecast to surpass $10trn by 2022, according to The Economist Intelligence Unit. Just over half of this is in North America, where health care makes up 25% of the US Federal Government budget. The industry growth is reflected in listed companies, where health care companies in the Russell 2000 index averaged revenue growth of 23.2% in the five years to December 2018: faster than any other major sector. 


Health care companies in the Russell 2000 index averaged revenue growth of 23.2% in the five years to December 2018

Drug innovation

Pharmaceutical innovation is one growth driver that is gathering momentum. The FDA approved 59 new drugs in 2018 and 48 in 2019, versus an average of 37 per year between 2010 and 2018. Four accelerated approval routes are expediting the process: the Fast Track (FT), Breakthrough Therapy (BT), Accelerated Approval (AA) and Priority Review (PR) designations all streamline various parts of the process, and approval times have been falling. The FDA’s Centre for Drug Evaluation and Research (CDER) has approved multiple new molecular entities (NMEs) and new therapeutic biologic products. These include genuinely novel drugs, and other cases of new and expanded uses for already approved drugs. Certain drugs are now approved for treating ten or more conditions in addition to their original use case. The majority of innovation emanates from the United States, but in November 2019, for the first time, the FDA approved a rare cancer drug based on data mainly from trials in China. The US FDA tends to move faster than other regulators, such as the European Medicines Agency (EMA) – with which it may have differences of opinion and timing over some drug approvals – but European and Asian regulators agree with the FDA most of the time.

FDA approvals in 2019 included treatments for reasonably common diseases including Parkinson’s disease, multiple sclerosis, migraine and depression, as well as many “orphan” drugs for much rarer conditions, such as cystic fibrosis or sickle cell disease. In 2019, 21 out of 48 new drug approvals (44%) were for orphan diseases, which the FDA defines as those affecting fewer than 200,000 Americans. Orphan drugs can still be very profitable, with an average price of $140k per year in the US, according to EvaluatePharma.

In major markets (the US, Western Europe, Japan and China) there are over 400 treatments in the pipeline, according to the Informa Pharma R&D Annual Review 2017. Treatments focus on areas such as gene therapy, CRISPR, stem cells, RNA and Car T. For instance, more precise genomic editing can target mutations.

These transformational technologies are investible via equities. In general, the number of US listed companies has been declining and has roughly halved from c 8,000 to c 4,000 over the past 25 years. Biotech is an exception in which more companies are coming to the public markets: some 243 listed between 2014 and 2018, according to EvaluatePharma. Now nearly 600 biotech companies are listed on US exchanges, per Bloomberg data. Below we highlight a handful of the most promising new trends.


Six of the world’s highest ten selling drugs target various types of cancers, according to Informa.

Quote from Manager A

“One exciting theme for the manager this year has been precision medicine within the oncology area. The manager holds several positions in companies that have excellent kinase inhibitors that act on one of the most important pathways in oncology (the RAS pathway). This pathway is often hyperactive in cancer due to mutations in the key kinases. In June, Pfizer agreed to acquire one of the companies at a hefty premium to the previous close.”

Genetically targeted therapy

Genetically targeted therapy, targeting specific genes, proteins and cells, is an example of how precision medicine can treat conditions more efficiently and with fewer side effects than approaches such as chemotherapy, which might impact all cells.

Quote from Manager B

“The FDA approved a record 59 novel medicines in 2018. Of those, a record 17 are genetically targeted. The manager expects this trend to not only continue, but for genetically targeted therapies to become the majority of new therapies over the next decade due to the speed and ease with which these medicines can be developed.”


One example of targeted therapy is immunotherapy. Some viruses, such as superbugs, have evolved to outwit old treatments including certain antibiotics, but medical science is also advancing as immunotherapies train the immune system to fight back against viruses, diseases and new mutations thereof. Car T is an example whereby a receptor can modify “T” immune cells so that they attack cancer cells.

Devices, digitisation, diagnostics and AI

New drugs are far from the only form of innovation: there are also treatments, devices, equipment, and procedures, such as robotic operations.

Digital delivery of health care and data management can widen accessibility and enhance efficiency in many areas. Deloitte’s 2020 Global health care outlook report says: “Technologies such as cloud computing, 5G, Artificial Intelligence (AI), Natural Language Processing (NLP) and Internet of Medical Things (IoMT) can help streamline health care delivery and align it with changing consumer preferences”.

AI is being used to develop drugs, as pharma companies partner with technology companies. The first drug compound created entirely by AI will soon begin clinical trials. AI and machine learning hold out the hope of faster and less expensive drug development.

AI can also diagnose conditions faster, earlier and more accurately than humans: a google AI tool was found to identify breast cancer with greater accuracy than doctors, according to a recent study in Nature. Technology also opens up potential for more personalised medicine, tailored to take account of family histories and genetic configurations. Remote and robotic surgery can bring advanced techniques to wider populations, potentially in low and middle income countries as well as high income countries.

Quote from Manager C

“We have entered a remarkable period in health care, not too dissimilar to the period of the technology sector starting in the mid Nineties. We expect breakthrough medical advances in therapeutics, medical devices, and diagnostics.”

Sector valuations

Although large-cap growth stocks have led the market, investors may ask: have valuations become stretched? In contrast, large swathes of the health care sector are arguably much more attractive. “Not only are valuations for health care below the technology sector, they are below the 20-year average for the MSCI World Health Care Index,” says Boardman, who adds, “plenty of US listed biotechs are trading on less than two times cash”.

The most glamorous sub-sectors in the current bull market have included software as a service (SaaS) and electric vehicles, where valuations are sometimes measured in multiples of sales rather than profits, not least because the latter are sometimes non-existent. Health care is also not the most fashionable sector when global economic momentum may be rekindling, but the US is currently experiencing its longest ever economic expansion. When a recession does eventually materialise, relatively defensive sectors such as health care might even benefit from a valuation rerating. Boardman believes that “investment generalists are underweight of the sector”. In the meantime, managers adept at picking winners have outperformed both the sector and the wider US equity market. Hedge funds have in fact been active in health care stocks: as many as 50 have appeared on the Goldman Sachs VIP list of the most popular hedge fund long positions.

Quote from Manager A

“It is an exciting time to be an investor in the health care sector. The pace of innovation and clinical data flow continues to accelerate in the life sciences industry. Additionally, the market has not rewarded this level of progress to the point that is deserved. While the overall sector has lagged the S&P 500 on performance metrics, individual companies generating real breakthroughs continue to be rewarded. This has always been the case in the life sciences space, and it is the reason why outperformance is possible even during down periods.”

Corporate activity

The past few years have seen mergers amongst pharmaceutical giants, as well as acquisitions of smaller and more dynamic biotechs. The giants need to find new drugs because their existing blockbusters will eventually be threatened by biosimilars and/or generics. Given that it still takes years and billions of dollars to develop a new drug, it is often much quicker and easier simply to acquire smaller firms. Such takeovers can be financed at interest rates near zero in many European and Asian countries.

Health care mergers and acquisitions across all sectors, including private deals, rose eight per cent in 2019, with 768 transactions announced or closed in 2019, compared with 705 in 2018, according to data from Hammond Hanlon Camp LLC (“H2C”). On top of well-known multi-billion deals in pharma, which are often cross-border transactions, there are plenty in hospitals: behavioural health (including addiction and autism treatment centres); health care IT; post-acute health; laboratories; physician practice management and ambulatory surgery centres. In health care IT, 134 companies were acquired in 2019 of which 74 were in SaaS. Acquirers included both health care companies and technology giants.

Dispersion and shorting

In any year, the top performing Nasdaq Biotech constituents see their share prices rise by 150% to 450%, while there are a handful of names down 80-90%. The Nasdaq Biotech Index roughly quadrupled between 2011 and 2015 but has not made another new high since 2015. This is arguably now more of a stock-picker’s market than ever.

Health care is a secular growth story, as populations age and more conditions become curable and treatable. There is a strong case for long exposure, but there will also be overvalued firms – and new treatments will create losers as well as winners. There is also an element of hype around some companies. The best managers aim to be long of the disruptors, and short of those who are disrupted, or sometimes even fraudulent companies.

Politics is another risk, which may be another opportunity on the short side or could require some portfolio hedging. There are fears that a Democratic presidency could lead to harsher regulation of health care and drug pricing, but this would require support from Congress and the Senate as well, which may not be forthcoming. In any event, the past few years show that volatility around the vagaries of opinion polls can provide further trading opportunities for nimble managers.