The intersection of technology and healthcare
Coordinator: Welcome to the Center for Investment Excellence, a production of JPMorgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment themes.
Today's episode is on the intersection of technology and healthcare and has been recorded for institutional and professional investors. I'm David Lebovitz, Global Market Strategist and host of the Center for Investment Excellence. With me today is Anya Schiess, Co-Managing Partner of Life Science Private Capital at JPMorgan Private Capital and Patrick McGoldrick, Managing Partner, Growth Equity, JPMorgan Private Capital. Welcome to you both to the Center for Investment Excellence.
Anya Schiess: Thanks, happy to be here.
Patrick McGoldrick: Thanks for having me.
David Lebovitz: Well, we're glad you're both are able to join us today. I think we're going to have a really interesting conversation, not only about what's going on in kind of private markets broadly, but, you know, really double-clicking and zooming in on what's happening in the healthcare space and the life science space, which is obviously front of mind, not only from a micro perspective but from a macro perspective as well.
And so let's just dive right in here. And Patrick, maybe I'll start with you, can you help us set the stage and talk a little bit about what private markets have gone through over the past couple of years? Obviously, 2021 was very different than 2022, which has proven to be different than 2023, and give us a sense of what you're seeing in terms of where things stand today?
Patrick McGoldrick: Sure, and thank you again for having us, David. So I actually think before we get to the last two, three years it's just helpful to orient people with contextually what has transpired over the last decade in private markets and why, right?
And so if you go back to just post the 2008, 2009 financial crisis, you had this low interest rate environment, certainly driven by a need for growth, but alternatives, or private markets in aggregate, went from $3 trillion in 2010 to today $10 trillion in assets and what is expected to be $17 trillion in AUM by 2026. And I bring that up because there's been this massive wave of capital looking for higher yielding assets, alpha generation and alpha creation.
And within the world of buyout, which is about 39% of the $10 trillion of assets, and in venture and growth, those have been critical areas for portfolios and for seeking higher levels of return. But that $10 trillion stands as just 9% of total AUM across asset management as an industry, so there's still massive ways to go from a growth perspective.
Now, you asked the question about the last couple of years, and it's certainly been a tumultuous ride for private markets. In the wake of COVID, massive stimulus, you had low interest rate environment, Fed balance sheet ballooned to $10 trillion, I think that's been well covered and documented. But on the flip side, in the beginning of 2022, you really saw this correction.
And the mantra of growth at any cost was completely changed to growth at a reasonable cost. Focus on the fundamentals of an underlying business, what were the unit economics or the ability of a company to scale efficiently and sell their product or service for a far greater yield than what it costs to acquire that customer. And that mantra isn't going anywhere, particularly in the wake of what is the third-fastest Fed rate hiking cycle in history behind the 1980s and 1970s.
So if you look at this, from two vantage points, there's the company side, as we talked about, that focus on efficiency growth, but it's also the lack of capital availability. And I know a lot is made of the dry powder, but the reality is that cost of capital being much higher, and the non-traditional sources of capital dissipating from the market, think sovereign wealth funds, hedge funds, which have grown a staggering rate, you know, 76% of that capital, that non-traditional capital, is out of the market.
And so for companies it's how are you growing efficiently? How are you growing prudently? What's your burn ratio, your burn multiple, and what does that look like over time? And what's that clear, well-chartered path to getting to profitability?
And we're just now seeing investors who took their foot off the gas in the midst of a valuation reset in the private markets, that's starting to thaw, right? So Q1 to Q2 there's a pickup in investment activity. And we'll talk a little bit about artificial intelligence and the driver that, that has been, but I do think you're seeing a reset of expectations on both sides.
And on the fundraising side, is the other side of the coin, that's been a very challenging environment. You've seen one of the most uncomfortable environments, I'd say, for fund managers looking to raise capital.
Part of that is this industrialization. So I started with those figures very intentionally of $3 trillion to $10 trillion because there's been a little bit of an industrialization of venture and growth. And what investors are stating unequivocally is we want expertise, a focus on returns, and a true measure of differentiation.
And if you're not providing that disparate view of $3 of interest from private equity, VC, growth firms looking for capital, to $1 of investment appetite from the LP side, you're just going to be at a disservice. And so it's a really interesting dichotomy we're seeing in the market today.
David Lebovitz: And I think you make really a number of good points. You know, one of the things I heard you say is that it sounds like markets might actually go back to doing what markets are supposed to do and directing capital in the right way and not just becoming kind of a blank slate where anything you throw sticks to the proverbial wall, but also that LPs and investors themselves are becoming more and more granular and focused when they think about allocating to private markets, not only about which strategy, but increasingly also about which sector and which industry.
And so, Anya, I'd love to bring you into the conversation, you know, your expertise is in life sciences. That's obviously a key area of focus for our clients.
And so can you talk a little bit about what you're seeing in the context of that space today? And then we're going to tap back into Patrick to talk a little bit about tech and AI, but over to you first for a glimpse of life sciences.
Anya Schiess: Yes, thanks David. So within healthcare, it's a little bit different. So while the past year, for example, has seen an overall decrease in dollars in the venture capital, in the healthcare it's actually up, and it's been up relatively sequentially year on year every year now.
Within healthcare, biotech has really become an asset class of its own. And that's interesting because if you look among the most sophisticated LPs, and you talked to them ten or 15 years ago, they would be able to tell you what their allocation to healthcare was, you know, similar to the allocation to tech or other industries, but they wouldn't have been able to break out biotech specifically.
That's very different today. You talk to the most sophisticated LPs today, and they have a very specific allocation to biotech, and that's sort of top of mind and all the rest. And that's led to an overall increase, of course, in assets being allocated to biotech.
But some similarities and some differences, from what Patrick was noting in overall funding, similarities bridge rounds are way up, right? So bridge rounds are almost double what they were in the past, so last year, $250 billion in bridge rounds, this year $480.
Valuations in later stage rounds have fallen modestly, right? So Series C is down about 20%, Series D is down about 18%, but the differences are in healthcare and in biotech, early stage. So Series C and A, and even into B, have stayed pretty flat, we're not seeing the decreases in valuations that we are at the later stage.
And a lot of that is because the exit engine for biotech, which is being acquired by incumbent pharmaceutical or other healthcare companies, is driven by patent expiries which is clearly uncorrelated to the macro markets. And as the listeners may know, about 80% to 90% of revenue is lost as soon as the patent expires.
So I mean, almost day to day, certainly within a quarter, and so big incumbents they acquire their new revenue, and that is what is generating this exit momentum. This year, as an example, over $115 billion in announced acquisitions have taken place, so we're on pace for almost $180 billion in 2023 alone.
To give you just a relative sense of how big that is if you look at an average fund cycle, which invests typically over three years, only about $6.5 billion is invested in biotech companies in a normal fund cycle between seed and Series D whereas we're on pace for almost $200 billion in exits this year. So, you know, I think that's keeping life sciences a little bit more buoyed than we'd otherwise see.
David Lebovitz: Well, it certainly seems like the space has the wind at its back. And I think your point about the differentiation in terms of the drivers, you know, not being correlated to the macrocycle, because so much of it is about patent expiry, that, you know, it really is a space that to an extent kind of beats to its own drum.
And speaking of drumbeat, Patrick, the drumbeat around AI has been getting louder and louder and louder here. And so given what Anya just shared about healthcare, and biotech, and life sciences how is that similar? How is it different from what you're seeing in the technology space more broadly?
Patrick McGoldrick: You know, it's a great question, David, because I think - well, maybe to one point, just to echo that Anya said about healthcare, is I think in the midst of what you saw a huge retracement in the public markets. Years of frankly underperformance or even companies trading below cash, that expertise, that discipline around knowing where to invest is I think never made a better case for active investing in the venture and growth space.
And what history has told us is these tend to be the best vintages to invest particularly in life sciences, where you see these massive market corrections, and then these periods of uncertainty and then real value created as the philosophy of the companies is to do well, the investors, the decision-making I think is much more intense and acute. And so I do think that specialization resonates.
In technology, you know, I think it's funny because the last five to ten years you may have been at risk for thinking, I could do this at home, and frankly, you saw a lot of investors pursuing that strategy. But if I described a $3 trillion opportunity in which you had peer to peer exchanging of value, frictionless payment, large automotive companies accepting a form of currency as a means of buying a car, you might say, well, wow that sounds like an amazing investment opportunity.
But then if I told you, it was cryptocurrency, and 70% of the value has been lost in the last 18 months, and regulation is very quickly following suit and the scrutiny associated with that, you might say, well, of course, you shouldn't have invested in that. And that's not just true in crypto, that's true in non-fungible tokens, that's true in 3D printing, that's true in AR, VR.
And my point being I think our job, as investors, is really to look at the lens and build a mosaic, a thesis around where is there opportunity? Is this the right time? Is this a structural shift? Are there tailwinds to the fundamentals of these companies really warrant investment?
And then very importantly to discern between a great company, or a great product, and a great investment because both need to be true in executing in a strategy. And so I'd say you mentioned artificial intelligence, I mean, the capital that's been invested in that space has been eye-watering $40 billion in the past 12 months, 50% of Series B financings year to date have been from artificial intelligence-related startups. You had companies raising north of $100 million of capital and no product yet, and so true incubation or ideation stages.
And AI is a perfect example of where there's been a lot of run-up, I think for good reason, I do think this is a structural, transformative shift we're seeing that will permeate across industries. But, you know, if you look at S&P I think it's 70%, 75% of the gain attributed to the 16% year to date mark is associated with the Magnificent Seven.
But this quarter has really been when people are diving deep and saying, okay show me the results associated with artificial intelligence. And so for us we looked across the landscape from large language models to the infrastructure side of the business to where there are applications that may or may not have defensibility in their moats and understanding who the long-term strategic winners and then again where there are great investment opportunity.
And so it's a fascinating time to be evaluating this space with six or seven unicorns created this year. But it's one where you need to exercise a level of caution and a judicious thought process around where that seminal change is going to come from like we've seen over the last 20 years with a number of other categories like the Internet, and personal computer, or the mobile phone, et cetera. And so I do think this is a structural shift, but will take time to unfold in a bit more depth.
David Lebovitz: No, I think that you hit the nail on its head. And I had (Joe) Wilson on the other day, and he had the term, strong views loosely held to talk a little bit about the way he was thinking about AI. And I thought that that was just the right way to frame it, it's yes this is going to be transformative, but let's not get ahead of ourselves so early on in the process.
So, Anya, shifting back to you, so obviously, you know, life sciences from fundraising, from a valuation perspective, in a bit of a different spot than the industry more broadly. One of the things that we talked about, as we were preparing for today's conversation, was that a lot of the themes in the healthcare and the biotech space resonate at both the macro and the micro level.
And I would love to just get some sense from you of what are some of the most exciting things that you're seeing today? What are some of the trends you're seeing across the industry to help paint a picture of what's really going on beneath the surface in this industry?
Anya Schiess: Yes, there's a lot to talk about there. And first, I just echo Patrick's point that some of the best vintages for private funds follow bear public markets, so now is really an interesting time to look.
But the pace of innovation is probably the most exciting in biotech. It's the fastest I've seen in my career. The past ten years, as an example, has seen tremendous innovation in modalities. So what I mean by that is the means of how a drug is delivered, it could be a pill, could be other forms.
As an example gene therapy and gene editing, a lot of listeners have probably heard of CRISPR cell therapy. We've seen the first approvals in bispecific drugs, oligos, et cetera.
To put that in perspective, because I know that's a lot of sort of jargony terms, but to put it in perspective between 1996 and 2006 the number of proteins that we could target that were implicated in human disease increased 22%. Between 2006 and '16, 73%, in between 2016 and today, which is only seven years, 150%, so we've seen just a absolutely rapid escalation in innovation.
In addition to the scientific innovation, which is what I just talked about, the intersection of technology and biology has really taken off. For example, through technologies like artificial intelligence, which is allowing us to democratize healthcare in a way we've never seen before, and scale healthcare in a way we've never seen before getting more treatments to more people, faster and more economically.
If you just think about the scale of healthcare, $4-1/2 trillion in the US, 20% of our economy, more than $10 trillion globally. Even small improvements in efficiency can have huge economic implications.
And importantly, regulatory bodies, like the FDA, are pairing with industry to bring a lot of these developments. On the microscale, just to finish answering your question, David, some areas we find most exciting, obesity.
One of the best business models ever was Google Search, right? Obesity will be almost as big, per analyst estimates $100 billion in top line revenue, but at 80% gross margins that's an area investors cannot afford not to be in over the next ten years.
Neurodegeneration, we've finally seen the first drug targeted at Alzheimer's being fully approved by the FDA, that's a drug from a Japanese company called Eisai. That market could rival the obesity market in size and certainly an impact on human life.
Genetic medicines and rare diseases, I talked about gene editing, talked about CRISPR, that's an area that's really exciting. And even really crowded areas, like oncology, can be interesting in select places.
For example, antibody drug conjugates, which is a newer way of delivering drugs to tumor sites, is a space we're really excited about. We just saw the largest ever announced acquisition of a biotech company, Seagen from Pfizer, for $43 billion a few months ago. That's in the antibody drug conjugate space.
David Lebovitz: Awesome. Well certainly lots of very positive news coming out of the space, a lot of really interesting developments. But I want to wrap up our conversation by forcing you to tease out something that you mentioned.
And you mentioned regulation, you know, when we think about investment opportunities we always think about the opportunity, but we also think about the risk, right? And when I think when it comes to things like AI, and obviously when it comes to the development of all of these different therapeutics and drugs, you know, we need to be sensitive to the regulatory risk but the risks more broadly.
And so, Anya, maybe we'll stay with you to start, and Patrick give you the final word, but what are the big risks when you look at your investment landscape today? And more importantly, how do you think about managing them?
Anya Schiess: It's another great question. I mean, from a biotech perspective, it's really pricing and regulatory approval. So the IRA, passed a couple years ago, had a provision in it to try and address drug prices, which first of all only really impacts the top spending drugs from the Center for Medicare Services, called CMS.
First of all, if any of our drugs ever get there we've already won, right, because it already means it's one of the top spend areas. But even if you look overall analysts estimate that's really only going to decrease drug prices by 3%. So overall we don't see, despite the rhetoric you hear, we don't see in the market nearly as many headwinds as you might expect.
I think who will really feel drug pricing headwinds are the middlemen, so these are the pharmacy benefit manager type of folks. And if you look where growth has been, in terms of prices and where those dollars have gone, a lot of it has gone to the middlemen and not the innovators.
So when we look at it from a biotech perspective we don't expect those headwinds to really hit our companies very much. The key caveat, though, is that you have to be investing in best of class companies and best of class treatments. If you're not investing in treatments that truly move the needle for patients, then everything that I just said kind of all bets are off.
And that's the same on the regulatory side. I think on the regulatory side you're needing to bring in more endpoints than just efficacy, meaning did your tumor shrink or progression free survival or things like that, and bring in more endpoints that are focused on quality of life and things like that. And that sort of helps support both the pricing as well as the regulatory approval.
David Lebovitz: Excellent. And Patrick, what about from your end?
Patrick McGoldrick: So I think overarching both life sciences and technology, I will say this David, is working with regulators and understanding what is next on the horizon, understanding from public companies, private companies, what is top of mind, where the concerns exist.
And so as Anya walked through some of this detail it's infused with perspective from some of the largest public company operators, and some CEOs, and chief scientific officers of these companies. And I say that as a prelude to my answer because I do think innovation tends to outpace regulation most often in the private markets.
And so knowing what is coming, and really making that a part of your investment criteria, is critical. And the repository of data that you're drawing upon, the resources, is influential in making the right decision.
So for the technology side it really spans the gamut from both intentionally designed regulatory risks, right, so artificial intelligence, you have the AI Bill of Rights that's been ushered in. It's a bit lacking in structure and definitiveness, but it's the beginnings of a discussion that will inevitably control some of the governance around a really influential part of the technology landscape.
You have questions though around copyright, and integrity of the underlying data and consumer privacy. And it's just a very quick changing landscape that we have to be ever present and focused on.
And then you have unintended regulations. And what I mean by that specifically is you look, again, back to 2008, 2009, Dodd-Frank, you have the Durbin Amendment that was passed.
And the unintended consequences of that were a massive boom and catalyst for Fintech, and open banking, and really affording consumers a different way of accessing a financial institution. And even today there's active debate about, well, should financial technology companies really be given these privileges and given a kind of a more competitive advantage?
And actually Jamie Dimon, our CEO, has spoken openly about some of the limitations of that places. But for us we stay very attuned, as one of the largest enterprise customers in the world, of these companies that ultimately we're looking to invest in on the private landscape as to what are those risks they face?
How do we help mitigate or shape or provide an opinion that lends itself to creating more favorable outcome from an investment lens while being ever mindful of those risks? And I think, you know, we have a lot of advantages in that respect.
David Lebovitz: I'm not sure that I could have put a bow on it better myself. That was a fantastic conversation, so thank you both for joining me, and I'm looking forward to having you both back on another episode sometime soon.
Anya Schiess: Thanks, David.
Patrick McGoldrick: Thanks, David.
David Lebovitz: Thank you for joining us today on JPMorgan's Center for Investment Excellence. If you found our insights useful, you can find more episodes anywhere you listen to podcasts and on our Web site. Recorded on August 22, 2023.
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