Franklin Templeton combines a close understanding of the companies they invest in with meticulous market research. The result is a BENCHMARK Fund of the Year Retail Top 100 Award, Best in Class in the Equity Biotechnology sector.
Evan McCulloch, Senior Vice President, Director of Equity Research explained that: “We have developed a multi-style investment approach that emphasizes flexibility. We combine bottom-up stock selection principles with an analysis of top-down industry themes, researching the best individual risk-return opportunities available,” adding, “this disciplined process, founded on in-depth, original research and anchored in a long-term outlook, can potentially achieve above-average performance and below-average risk.”
Before the managers consider an issue for inclusion in a portfolio, the stock goes through a vigorous selection process where many aspects are considered: “We look for companies that are trading significantly below our estimation of their intrinsic value. Then we construct a discounted cash flow base case that includes currently commercialized, and developmental stage products that we believe have a high probability of ultimately earning Food and Drug Administration (FDA) approval. We also explore the revenue projections for those products,” pointed out McCulloch.
“For our revenue forecasts, we review the epidemiology of the disease, learn the treatment algorithm and determine how that drug will act with other existing and developmental medicines. We also look at how the drug will be priced and assess the patents to determine the market exclusivity period. From this, we build detailed models.”
The Key to Success
To determine the probability of a drug’s success, the team reviews scientific literature, scrutinizes prior clinical data, assesses the design of future trials and examines the risk-benefit profile, just as the FDA (US Food and Drug Administration) would.
“Throughout this process, we rely on our in-house research, such as reviewing published literature and interacting with company management teams. We also draw on the experience of a network of industry experts, which includes academics and community physicians, reimbursement personnel and patent attorneys,” noted McCulloch.
“There can be no doubt that the drug development industry is at times risky and uncertain. In the early stages, biotechnology firms face the risks associated with trial results, regulatory approval and competitor developments. In addressing these issues, we use a disciplined research process and position size as an effective risk management strategy,” adding, “we invest less in developmental-stage companies with few products, and more in commercial-grade companies with multiple offerings. This way, the downside impact of a single binary event is minimized.”
Changes to the Tax Regime
The new US administration’s plans to reduce corporate tax could prove broadly beneficial for the sector. McCulloch explains: “The potential repatriation holiday, or a reduction in taxes for repatriated earnings, would be the most significant outcomes. We would view any reform here as a positive for the biotechnology space. Many large biotech and pharma companies have large amounts of cash held overseas, which they could bring back home, helping them to invest in research or return to shareholders through buybacks or dividends. It would also likely trigger M&A activity, which would be positive for small caps.”
Looking at current holdings, McCulloch noted that: “We favor drugs which are best-in-class, are in an area of unmet clinical need or provide a benefit for patients.” Observing that: “The recent innovations in cancer treatment fit several of our most important investment criteria. Targeted immuno-oncology therapies look to be more effective than traditional chemotherapy and cause fewer side effects, resulting in better outcomes for patients.”
Another area of interest for McCulloch and his team is a treatment for so-called ‘orphan diseases,’ which are conditions which affect a small number of people. “While uncommon, these genetic disorders are often fatal,” McCulloch explains, “so there is a significant amount of unmet medical need for treatments. Given the relatively small number of case and the seriousness of the conditions, the FDA often waives or fast tracks the clinical trial process for treatments as well.”
Indeed, McCulloch is extremely positive about the dramatic cancer research breakthroughs which are currently in progress: “We are impressed with the progress the sector has made.” he says. “In particular, we are excited about some of the emerging technologies like gene therapy and gene editing. Moreover, the entire field of immuno-oncology, or the harnessing of the human immune system to fight cancer, will bring dramatic advances.”
Focus on the US Market
The team has a strong preference for the North American market. Although it does invest in companies located elsewhere, the US remains in focus because it is such an important center of medical research, venture capital and ultimately patients and revenue. Over 90% of the benchmark NASDAQ Biotechnology Index is comprised of US-based firms, although many of these companies do operate in countries across the globe.
A Healthy Backdrop
Looking at the year ahead, McCulloch believes the fundamentals in the biotech and pharmaceuticals industries are robust. There is a new wave of innovation occurring across the sector, and the team like companies that focus their efforts on new drug-discovery platforms, novel compounds and areas of significant unmet medical need. In particular, they concentrate on the areas of immune-oncology and gene therapy, both of which have the potential to transform cancer treatment.
The benefits of heightened development and new-product pipeline activity are visible. Even though volatility is a potential threat, as longer-term investors the managers use market selloffs to make selective stock purchases in companies which combine the development and sale of innovative drugs designed to treat diseases of high unmet need.
Against any real or perceived pricing pressures in the consumer marketplace, McCulloch sums up the team’s approach: “We view investing in companies with differentiated products and platforms, as well as innovative research and development as the best defense.” BM