Will Brooks and Jeremy Curnock Cook, 17 April 2019
The healthcare sector has seen huge investment growth and more specialised products starting to emerge. Two specialists navigate what is on offer.
Global spending on healthcare is projected to reach $10 trillion by 2022. Venture capital flowing into UK medtech companies has doubled over the last year. It is a marketplace of tremendous growth. The challenge for investors is finding the novel solutions that can reap attractive returns. But with limited retail opportunities still, and unfamiliar products and services all presenting different risk and time horizons, understanding this complex sector is not easy. Nor is gauging when and where wealth managers should get involved.
WeathBriefing asked two sector specialists in the field to cut through what the funding ecosystem looks like – from developing new drugs to capitalising early stage medtech firms – and the outlook for healthcare investing as it moves into the mainstream.
The co-authors are Will Brooks, who directs the healthcare activities at Downing LLP venture funds, and Jeremy Curnock Cook, managing director at BioScience Managers, a group advising the investment manager on its healthcare venture capital trust.
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Global investment into healthcare continues to grow, supported by a number of market and investment trends. The global healthcare sector itself is growing, with spending projected to increase at an annual rate of 5.4 per cent in 2017 to 2022 from $7.724 trillion to $10.059 trillion, according to a Deloitte study. This is being driven by ageing populations, advances in medical treatments and an increase in chronic conditions. The UK’s healthcare sector shows similar growth potential, with the size of the private and public market expected to increase from £165.8 billion ($215 billion) in 2016 to a projected £186.1 billion in 2020.
In addition, the introduction of innovative technologies into healthcare is radically transforming much of the industry and creating a host of new companies in need of early-stage capital. Healthcare technology is only just beginning to hit the mainstream, and so is attracting the attention of investors of all types.
The sector is also benefiting from a shift in investor behaviour. Following high-profile instances of unethical behaviour at large corporations, and opaque business models, investors appear to be taking a much keener interest in the types of companies they are investing in and the returns they are likely to receive. Against this backdrop, healthcare companies are seen to be delivering a tangible benefit to humanity, particularly at the smaller end of the scale where a high degree of transparency can be offered into potential investments.
The funding ecosystem
Within this growing sector, the funding ecosystem can appear diverse and complex. ‘Healthcare’ includes a number of subsectors, including drugs, devices, diagnostics and digital technology, all of which have different risk profiles and time horizons as they transition from concept to commercialisation. Drug development, for example, is a high cost, lengthy process, and so funding typically comes initially from specialist VC funds, operating on perhaps a 10-year basis.
Following proof of concept, further funding may be available through licensing and royalty agreements, and IPOs. Diagnostics and devices (medtech companies) in contrast tend to have a much shorter route to market, and so in addition to venture funds, can be funded through partnerships with technology companies, or asset funding.
This diversity means that investors must think carefully about the types of company they wish to invest in and through which channels, depending on their objectives, attitude to risk and time horizon. Factors for consideration include the risk profile (typically higher in drug development, lower in devices and diagnostics), quality of management, the stage of the development, the exit timeline and potential, the commercial opportunity and costs associated with this commercialisation.
The rise of VC
Venture capital has long been considered an attractive form of investment into healthcare, with eye-catching returns when investments are successful. One example is the success of Sirna Therapeutics, which emerged from the ashes of Ribozyme Pharmaceuticals with less than $15 million in the bank and was sold to Merck in 2006 for $1.1billion.
More recently, VC has become a dominant form of investment. The latest figures from the UK BioIndustry Association (BIA) for Q1 2019 showed that while the healthcare sector as a whole continued to grow, the proportion of VC capital increased to 66 per cent, up from 34 per cent a year ago, attributable to attractive technological innovation in the sector. This is giving rise to a growing cohort of companies applying new technologies to develop novel solutions in areas such as drug discovery and development, diagnostics, digital health and genomics.
In the Downing FOUR VCT Healthcare Share Class portfolio, for example, there is a diverse array of innovation. Arecor has developed a new formulation of super concentrated insulin with the potential to transform diabetes care; Destiny Pharma is one of a number of small companies developing solutions to the problem of antibiotic resistance; Adaptix has developed a new form of 3D imaging that provides a more thorough, portable and safer alternative to X-rays that can be used in a number of different contexts; and Open Bionics has developed the world’s first medically certified, 3D printed bionic hand.
Accessing high growth
Within this VC landscape, the challenge for wealth managers can be how and where to get involved, with the majority of VC funds based on institutional capital and a lack of investment options available to individuals seeking access to fast growth UK healthcare companies.
At the larger end of the scale, some investment funds/unit trusts are available, including specialist funds like the International Biotechnology Trust and generalist funds known for making healthcare investments such as those managed by Woodford Investment Management. The focus of such products is long-term and international.
In contrast, smaller scale options include wealth clubs, regional investment networks, or even individual EIS investments. All these options can provide exposure to small, high-growth, high-risk companies with potentially shorter investment terms. However, the challenge can come in harnessing the necessary expertise to construct a balanced portfolio that diversifies risk while delivering returns within the desired timeframe.
A third style of investment is through EIS funds or Venture Capital Trusts (VCT) – such as the Downing FOUR VCT Healthcare Share Class, which is managed by the healthcare team at Downing LLP and advised by BioScience Managers. Unlike larger venture funds, these products focus on a shorter investment term of around five years and invest in a portfolio of UK SMEs with high potential for growth. In addition, EIS and VCTs come with attractive tax treatment including income tax relief, capital gains tax exemption on exit and tax-free dividends (VCTs only) over the course of the investment, although it should be noted that investing in VCTs is high risk and tax reliefs may change and are subject to personal circumstances.
This style of investment is relatively new to the healthcare sector, as VCTs historically have often been considered unsuitable due to the complex needs of complex businesses, as well as the timescales involved for subsectors such as drug development. However, the maturing intersection of health and technology has created a supportive environment in which healthcare investing is viewed as a mainstream opportunity accessible via a specialist skillset.
The importance of expertise
This is another important point for wealth managers looking to access the healthcare investment landscape, and particularly the high-growth opportunities presented by VC in the sector. With high reward comes high risk, and so expertise is essential. The experience of funds such as BioScience Managers, whose team has decades of experience investing in the healthcare technology sector, has shown there are no short cuts to selecting the right companies and the right management teams, and that you cannot be afraid to make course adjustments along the way.
The combination of digital and healthcare technologies brings new challenges to even specialist managers, who are increasingly looking to hire people who understand the power of digital technologies to work in partnership with healthcare-focused colleagues who are thoroughly comfortable with the medical regulatory environment. While many investment managers will have some healthcare expertise present to advise on generalist funds, investors should seek out specialist teams with extensive industry experience in both digital and healthcare sectors.
A route to success
There is no doubt that the healthcare sector presents exciting potential opportunities for nearly all kinds of investor. However, as a large and diverse sector it should not be over-simplified, with careful attention paid to ensure that risk and timescale match investment objectives. As technology transforms healthcare, VC funding is at the forefront of that innovation and so an exciting place to be involved. Here, selecting investment managers with deep experience of the digital and healthcare industries is essential when aiming to mitigate risk and maintaining upside potential.