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Over the course of the COVID-19 pandemic, and off the back of news of successful trials for some potential vaccines, biotechnology has come to popular attention. Should it also be part of your investment portfolio?

Biotechnology has obvious appeal from a social and moral perspective but it has also experienced extraordinary growth in recent times. Biotechnology is predicted to be valued at more than US$833.34 billion by 2027, compared to US$447.92 billion at the end of 2019, and will continue to grow, driven by the growing global population and the need for affordable, effective treatments and vaccines.

What is biotechnology?

Biotechnology specifically refers to technologies that use biological processes, capturing companies that focus on research, development, manufacturing and marketing of products based on biological and genetic information. The different types of biotechnology includes biological drugs, vaccines, immunotherapy, gene therapy, orphan drugs and genetic engineering.

While the Australian industry has a number of dominant players, such as CSL (ASX: CSL), Cochlear (ASX: COH) or Resmed (ASX: RMD), the US tends to be positioned as the global centre for biotechnology. The reason for the US dominance in this field is due in part to the world-renowned US Food & Drug Administration (FDA) approval process, and also, the size of its customer base.

Any companies seeking access to distribute their products in the US market need to pass the FDA evaluation and in turn, many companies have sought to base themselves there for easier access to the process and for easier distribution and marketing to US consumers.

Lucrative and risky

Biotechnology can be a high-risk industry, with significant costs for drug development and high chances of failure. The rewards for successful trials can also be immense.

To put this in perspective, in any given year, 54% of clinical phase 3 trials typically fail for a range of reasons. According to the Deloitte Centre for Health Solutions, average costs for developing a drug are estimated at more than US$2.1bn. The trials and approval process can take years, often 10 years or more, with less than 12% reaching approved status with the FDA.Biotech and healthcare companies then derive revenue from approved products using patents. These patents typically last approximately 20 years from the date of application, but also require maintenance fees, and in some cases, they can be extended.

This means generic, cheaper versions from competitors cannot be sold in this period, allowing a company an effective monopoly over a particular form of treatment in that time. Of course, once this patent expires, competitors can enter, so companies will continually research, develop and test on a permanent basis in the hope of finding the next major treatment they can generate revenue from.

Another source of return for this industry is from the high rate of merger and acquisition activity. Small and mid-size biotechnology companies are often targets for larger firms wanting to expand with complementary capabilities they might not previously have had. It a mutually beneficial relationship, providing small and mid-size companies with the capital they need to finance development and testing.

Mergers and acquisitions activity for biotechnology was valued at US$23bn in 2019. Pre-COVID-19, 2020 was tipped to see an increase in mergers and acquisitions activity, with oncology, cardiovascular/metabolic disease, immunology, infectious disease and central nervous system disorders anticipated to benefit.

Future growth potential

Alongside population growth, an aging population is also a focus for biotechnology.

The reason for this is that an increase in the volume of older citizens is likely to have an accompanying and proportional increase in the volume of age-related diseases such as cardiovascular disease, dementia or arthritis, all requiring treatment.Gilead (NASDAQ: GILD) is one example of a company with prospects in this space. Gilead is already well-known for its highly effective HIV treatments, but it is also targeting US and European approvals to market a drug called Filgotinib', to treat rheumatoid arthritis.

In a demonstration of the growth in this industry, this year alone, 30-35 biotechnology companies were anticipated to go public, raising approximately US$3.5bn.

The healthcare sector as a whole is likely to see greater investment as a result of the COVID-19 pandemic. For example, national health spending growth in the US is expected to average 5.4% annually through 2028, reaching US$6tr a year. Biotechnology will also be a beneficiary of this increased investment.

Why consider biotechnology in your investments?

Investment and value from biotechnology is expected to grow in the coming years. While the trend already existed due to continuous tech improvements and the needs of a growing and aging population, the COVID-19 pandemic has created a new spotlight on this area which may accelerate its growth.

While Australian investors are likely to already be exposed to this growth segment in the concentrated domestic market, they may be missing diversification and exposure to the US, which dominates the global market for biotechnology.

Biotechnology could be considered part of a sector allocation to healthcare, or investors might view it as a thematic investment. You can find more information about thematic investing and using it in your portfolio in our latest whitepaper.

Ways to invest in biotechnology

There are a range of ways to access the biotechnology industry.

Investors could consider direct shares in biotechnology companies or alternatively consider managed funds. Direct shares can be a high-risk approach due to the high failure rates of drug testing and long periods of development. That is, long periods where there may be no or a limited return on investment. There is also the element of chance. Namely, has the investor picked the winner? It could take years to know.

Managed investments, be it actively-managed funds or passive options like ETFs, can assist in managing risk by spreading it across a larger number of companies. Investors could choose to invest by taking a sector approach and investing in a fund focusing on broader healthcare, or look at industry-specific options focusing on biotechnology. ETFS S&P Biotech ETF (ASX: CURE) is Australia only ETF that offers broad exposure to US biotechnology.For more information on investing in biotechnology and ETFS S&P Biotech ETF (ASX: CURE), please contact ETF Securities directly using the details below.

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Information current as at 16 November 2020.