Professor Andrew Lo
There is growing consensus that the bench-to-bedside process of translating biomedical research into effective therapeutics is broken. In a paper published in the October 2012 issue of Nature Biotechnology, my coauthors, Jose-Maria Fernandez and Roger M. Stein, and I suggest that this is caused in large part by the trend of increasing risk and complexity in the biopharma industry. This trend implies that the traditional financing vehicles of private and public equity are becoming less effective for funding biopharma because the needs and expectations of limited partners and shareholders are becoming less aligned with the new realities of biomedical innovation. The traditional quarterly earnings cycle, real-time pricing, and dispersed ownership of public equities imply constant scrutiny of corporate performance from many different types of shareholders, all pushing senior management toward projects and strategies with clearer and more immediate payoffs, and away from more speculative but potentially more transformative science and translational research.
We propose a new framework for simultaneously investing in multiple biomedical projects to increase the chances that a few will succeed, thus generating enough profit to more than make up for all the failures. Given the outsized cost of drug development, such a “megafund” will require billions of dollars in capital; but with so many projects in a single portfolio, our simulations suggest that risk can be reduced enough to attract deep-pocketed institutional investors, such as pension funds, insurance companies, and sovereign wealth funds.
A key innovation of this proposal is to tap into public capital markets directly through securitization, using structured debt securities as well as traditional equity to finance the cost of basic biomedical research and clinical trials. Securitization is a common financing method in which investment capital is obtained from a diverse investor population by issuing debt and equity that are claims on a portfolio of assets—in this case biomedical research. Debt financing is an important feature because the bond market is much larger than the equity market, and this larger pool of capital is needed to support the size of the portfolios required to diversify the risk of the drug development process. In addition, this vast pool of capital tends to be more patient than the longest-horizon venture capital fund.
Our findings suggest that bonds of different credit quality can be created, which could appeal to a broad set of short-term and long-term investors. The results from the simulations we ran indicate that a megafund of $5 billion to $15 billion may be capable of yielding average investment returns in the range of 9 percent to 11 percent for equity holders, and 5 percent to 8 percent for bondholders. These returns may be lower than traditional venture capital hurdle rates, but are more attractive to large institutional investors.
To calibrate and test our simulation of the investment performance of a hypothetical cancer drug megafund, we accessed the databases of hundreds of anti-cancer compounds assembled by Deloitte Recap LLC and the Center for the Study of Drug Development at Tufts University School of Medicine. These simulations not only yielded attractive investment returns on average, but also implied that many more drugs would be successfully developed and brought to market. Such an outcome would be particularly welcome given the current scarcity of investment capital in the life sciences industry despite the growing burden of disease. One in two men and one in three women in the United States will develop cancer at some point in their lifetimes, making this one of the major priorities facing society.
We acknowledge that our analysis is only the first of many steps needed to create a private-sector solution to the funding gap in the life sciences industry. The practical challenges of creating a megafund would require unprecedented collaboration among medical researchers, financial engineers, and biopharma practitioners. Support from charitable organizations and the government also could play a critical role in expediting this initiative. In an extension of this simulation, we show that the impact of such support can be greatly magnified in the form of guarantees rather than direct subsidies. The MIT Laboratory for Financial Engineering will be hosting a conference at MIT in June where representatives from all the major stakeholder communities will be invited to explore these ideas together.
Finally, our proposal is clearly motivated by financial innovations that played a role in the recent financial crisis, so it is natural to question the wisdom of this approach. Despite Wall Street’s mixed reputation in recent years, we are convinced that securitization can be used responsibly to address a host of pressing social challenges. With lessons learned from the crisis and proper regulatory oversight, financial engineering can generate significant new sources of funding for the biopharma industry, even in this difficult economic climate. Raising billions of private-sector dollars for biomedical research may seem ill timed and naive—but given the urgency of cancer, diabetes, heart disease, and other medical challenges, the question is not whether we can afford to invest billions more at this time, but rather whether we can afford to wait.
