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Paul and Brett's Alpha

October 2023

The path to my fixed purpose is laid with iron rails, whereon mysoul is grooved to run

These are the most trying of times. The market has become like a monster, twisted and unforgiving. Nebulous fear is influencing behaviour and causing all to question reason itself. We have spent a significant amount of time with our investors over recent weeks, and many want for an explanation for the prolonged underperformance of our strategy, in spite of all manner of supportive data points that suggest it should be delivering.  

How could we disagree? October saw us annualising two years of underperformance versus the comparator MSCI World Healthcare Index, over which we have delivered a dollar NAV total return of -28.2%. It was not supposed to be like this.  

At this juncture, some are want to question our whole approach. Seldom have we been asked why we do not own a particular stock (or rather two – Novo Nordisk and Eli Lilly) and never before have people asked for us to utterly change our approach: “just buy them”.  

We have no intention of taking up either of these suggestions. This is not because we are as stubborn as Ahab and seeking to rebel against convention, nor are we on a mad quest. We have an approach that relies on a methodological approach – one that combines desired thematic exposures with a GARP-like valuation framework. That same framework has lead us to own Lilly in the past, and equally made continuing to hold the stock impossible, even as far back as Q4 2021, when this period of underperformance began.  

The current situation is not without precedent. Many of you demanded (quite fairly) to explain why we declined to own Moderna and BioNTech in 2021, at the height of the pandemic. Both stocks did very well, peaking at $484 and $447 per share, respectively. At the end of October, they respectively stood at $76 and $94, precisely for the reasons we articulated back in 2021. Perhaps we could have bought them and then sold them quickly, but the strategy we committed to is a low turnover, fundamental, long-term holding approach. In all likelihood, this would not have worked out as well as hindsight suggests. 

Neither are we so unpragmatic as to fail to recognise the situation for what it is. Anytime you underperform for a protracted period of time, you are “wrong” in the eyes of investors for that period. This is an indisputable and objective fact: had your investors chosen to invest elsewhere or not invest at all when the market’s absolute return is a negative one, they would have been better off.  

Of course, such things are only knowable in hindsight and such backward-looking considerations are simplistic; one didn’t know, and in most cases, one couldn’t possibly know what one knows now. However, this does not stop people from making emotional and reflexive rear-view mirror judgments.  

As challenging as this period has been, we could at least console ourselves to the middle of this year that investors had nonetheless still been better off in this product than one of the alternatives or a benchmark ETF. At that point, we were still modestly outperforming our benchmark year-to-date, and were optimistic that the likely zenith of the rate tightening cycle was just around the corner. However, the Q3 ‘GLP-1 meltdown’ since August has wiped all of this out.  

We are not hiding from any of these challenges, but at the same time it is worth noting that none of our peers’ returns are ahead of the MSCI World Healthcare Index since our inception date, nor are any of the UK’s Biotech Trust peers returns ahead of the Nasdaq Biotech Index over the same period. Active managers do not generally outperform idiosyncratic markets; not because we are all stupid, but because these types of markets are not rational, and so rational decision-making is not helpful.  

“Human madness is oftentimes a cunning and most feline thing” 

It bears repeating that we do question ourselves over performance and approach on a regular basis and must also satisfy the management of Bellevue and the Board of the Trust that we are following an approach that is grounded in robust data. For those of you who would like to know more, ask the Trust’s Board for a meeting or come to our AGM, where our format opens the floor to any and all questions around the investment strategy. We do not hide from our investors, in good times or bad.  

Moreover, we do actually appreciate and value the robust approach taken by both parties: one should never be satisfied in this industry and there is always something new to learn.  

Why then do we continue to stick with our approach, despite the present outcome it is generating? Based on our own thoughts and the feedback from our investors, many of whom are understandably concerned by current events, there are only really three obvious causes, when one tries to disaggregate how we got to be where we were at the end of October:  

  • 1. Fundamentals. Something really fundamental has happened, which has changed the way that the healthcare ecosystem works, imperilling the types of investments that we make.  
  • 2. Funding. Indubitably, the long-term financing environment is different now to two years ago and could remain so for some considerable time to come, potentially justifying a wholesale change in valuation approach.  
  • 3. Fashion. In the oft-repeated words of Benjamin Graham, the market can be a voting machine as much as a weighing machine. Before this, Keynes noted that irrationality can persist for long periods of time. It may well be that nothing, per se, is wrong and the approach we have taken and the stocks that emerge from that as our portfolio are simply out of favour (i.e., the idiosyncratic market). 

Let us consider these three points in more detail. 

“The fundamentals” 

Whilst everyone is entitled to their opinion, and some have offered suggestions around this notion, our conclusion is simple: we cannot find substantive evidence to support the idea of any fundamental change over this two-year period since the latter days of 2021 that would have a lasting bearing on either the revenue potential of the end markets that we seek to gain exposure to, or the probability of regulatory or commercial success for products, technologies or services looking to address these market segments. If anyone does have any evidence supporting such a conclusion, please send it along, and we will gratefully consider it.  

It bears repeating that healthcare is a complex and highly regulated marketplace, with long and expensive development timelines and high barriers to entry. The evidence-driven nature of medicine requires new approaches to prove their metal via studies reported in peer-reviewed journals that consider their cost, efficacy or safety benefits to patients and to the system as a whole and, in most cases, they must also satisfy a regulator such as the FDA that they have a positive impact versus the status quo.  

Thereafter, new products (drugs or devices), technologies and services must navigate some sort of procurement or tender process that will dictate the pace of market uptake. Simply put, nothing happens quickly in healthcare unless the rules are suspended, as they were during the pandemic. In this context, two years is the blink of an eye.  

As for the GLP-1 “impact” currently ailing the sector; it is, quite simply, nonsense, and we challenge anyone to prove otherwise (whilst appreciating the forward-looking nature of such an impact makes this challenging, just as it is impossible to disprove the negative scenario that underpins the whole GLP-1 disruption thesis – we must all rely on judgement and the totality, or total lack of, available evidence).  

For those who choose not to believe us (“there must be something to it, otherwise the market would not be reacting like this”), how about some sage words from the CEO of GLP-1 winner Novo Nordisk, in a recent Barrons article unambiguously titled ‘Selloffs on Weight Loss Drug Fears Are an overreaction, Novo CEO Says’: 

“I’ve seen companies doing, say, dialysis services, sleep apnoea, with massive share price reactions,” he says. “These are progressive diseases. And even if you start reducing people with obesity, there are many who have a progressed state of disease”… GLP-1 drugs, he says, are not a cure-all, and patients will still need other treatments. “It’s not that if you lose weight, then suddenly you don’t have kidney disease.” 

For us at least, that says it all. It is also what we have been saying to you for the past few months. That this current situation will unwind feels undoubted to us, the question is over what timeframe a more considered viewpoint will emerge. We hope that the publication of the detailed results from Novo’s much-vaunted SELECT study on CV outcomes with Wegovy over the weekend of 11/12 November will begin this process, but nothing is certain. 


The cost of money has risen. Unarguably, this will disfavour those who need external finance more than those who do not. As noted previously, healthcare development timelines are long and expensive. Ergo, pre-commercial companies now carry elevated risk due to re-financing needs, unless they are already funded beyond post-commercialisation, to cashflow breakeven. 

This is clearly going to impact small and mid-sized companies versus their larger, generally cashflow positive, brethren. It will further impact companies that are less diversified in terms of their product pipeline, since any setback has a more material impact if the proposed product cashflows account for a large proportion of the enterprise’s overall cashflow forecasts. 

One could point to the relative performance of the Healthcare sub-groups of the S&P500, S&P400 and S&P600 indices over this period (total returns of -3.8%, -29.6% and -41.5% respectively) as evidence to support this. Put another way, ‘size factor’ is simply a proxy for maturity and near-term cashflow.  

The perception has become the reality regardless. We are now asked regularly about the proportion of the gross exposure that is to companies with negative near-term operating free cashflow and how many of our investments will need to access the capital markets again before we expect them to become self-sustaining. We have also been asked if we consider such things in our investment approach (of course we do, and always have done). Investors have asked these questions before, but rarely. Moreover, our perception was that no-one seemed to be asking from a ‘risk management’ perspective, but more out of curiosity.  

Pre-commercial healthcare companies are likely to continue to remain reliant on equity funding over bank facilities. The intangible nature of the value creation (i.e., the bulk of the net present value lies in the creation of intellectual property and the obtaining of marketing authorisations, not in tangible assets like factories and offices that offer safe collateral for loans) and the risks and timelines associated with commercialisation remain both significant and uncertain.  

Even big companies cannot rush these things. In 2015, healthcare behemoth Johnson & Johnson formed a JV called Verb Surgical with those product development slouches at Google (via their Verily healthcare subsidiary) to enter the surgical robotics space. The platform they began to develop, now called Ottava is expected to reach the US commercial marketplace in 2027 (many years later than originally envisioned). Dozens of other surgical robotics platforms flounder along in no-man’s land. Meanwhile, first-mover (and portfolio holding) Intuitive Surgical goes from strength to strength. 

Is it fair to generalise and assume that everyone will struggle to raise additional funds? We do not think so. There have been dozens of successful, high-profile equity raises in the healthcare space since Q4 2021. The Trust has seen two portfolio companies successfully close follow-ons during 2023 and, in both cases, there was no short-term share price impact from these financings. On the other hand, poor companies will struggle to find support. This is how capitalism works: through natural selection.  

At the moment, we believe there are more “zombie” companies in the public equity realm than usual, because many took advantage of the pandemic’s raised level of interest in healthcare, allied to lots of first time retail investors trading at home during lockdown and the thankfully diminished “SPAC” craze of the period. Many of these companies would not have managed a successful public debut in more normal times.  

As ARM and Birkenstock amply demonstrate, the IPO market remains tricky and many currently private healthcare start-ups will need to remain so for longer than they hoped. This is not a problem for those already listed though, and the travails of the Venture Capital industry are, if anything, an opportunity for public companies: If you cannot exit your investment via IPO, then a trade sale (at keen prices right now) to an incumbent is your next best option. There will be many bargains to be had in the coming months.  

Coming back to the quality end of the listed space. As we have noted in previous factsheets, the only way to back-solve for the de-rating that we have seen across our portfolio would be to apply double-digit discount rates to everything, with some companies well into the teens. Yields on 30-year US Treasuries have risen ~300bp over the past two years (from ~200bp to ~500bp at the end of October), which is simply not enough to explain the de-rating we have seen. 

Indeed, this must imply a very material increase in the ‘equity risk premium’ for healthcare stocks. Investors need to decide for themselves whether or not a material increase in the ERP is justified. If it isn’t, and if you agree with the first point that the fundamentals of healthcare have not changed, then the patient investor should be piling into these de-rated small and mid-cap healthcare companies.  

One might counter that we have been in a multi-year de-rating cycle that may reflect a permanent re-assessment of valuation due to discount rates. Even if this is true, these companies will still grow faster than the market overall, driving a significant further de-rating. In other words, one does not need to presume a re-rating to drive target returns, only that the current multiples hold fast over the coming years and that future growth is rewarded.  

If you do agree with the second point (i.e., the funding environment has changed, but not so much as to justify the level of de-rating that we have seen in small and mid-cap companies), but disagree with the first point (i.e., healthcare specifically has suffered a material change in operating environment), then you might want to consider buying ETFs on the impacted indices to take advantage of a likely re-pricing of these sorts of companies. If you disagree with both conjectures, then maybe it is best to stick with the familiar, blue chip names. 


The stock market is faddish. Things go in and out of fashion for non-fundamental reasons. SPACs for example. Were these ever a good idea? Having looked at many, we have as yet only invested in one company that listed via a SPAC; we generally consider it a huge red flag. Our reasoning is simple: if you cannot convince the commitment committee of an investment bank that your company is ready for the public markets, then it probably isn’t.  

Academic research on the dilutive impact of SPACs versus traditional crossover funding followed by an IPO does not support the contention that it is a cheaper way for companies to go public, only that it is a faster way for the target company to obtain a listing. And yet, 2021 saw the launch of 107 SPACs that listed parts of the healthcare industry as their intended target, according to S&P Global Market Intelligence.  

The returns from these deals have generally been poor. It is not straightforward to support this statement quantitatively, in part because there are many arguments about what to compare SPAC returns to: should it be healthcare IPOs of the same vintage (as noted previously, this is a poor vintage in all respects), or healthcare in general? (returns have been poor relative to history across the space, especially in smaller-cap, which is usually where SPAC companies would be classified).  

We will spare our readers any words on market bubbles, for there are countless tomes in any good bookshop about this bizarrely repetitive occurrence. Keynes famous point about market irrationality is axiomatic. If there are bubbles, it surely follows that there can be “anti-bubbles”, the other side of the ‘price deviation from fundamental value’ argument.  

The fact that we cannot recall a catchy name for this phenomenon is telling. The investment approach based around it is, of course, well-known: value investing, as espoused by Benjamin Graham. If you search for recent articles on value investing, you are far more likely to find one proclaiming its demise than extolling its virtues.  

Growth has outperformed value for decades because we have been in a societal transition from the old to the new economy. Get online and move up the value chain or die. Basic manufacturing is no longer the forte of advanced economies, who will be undercut by their emerging market peers (cf. China, Vietnam, India etc.). As a consequence, money has moved away from value approaches toward passive index products, which unintentionally favour growth companies. 

We work, live, and spend differently today versus five, ten and twenty years ago and the value of certain sorts of legacy infrastructure is thus diminished (fixed line telecoms, some fossil fuel processing, some transport and leisure assets). This is nothing new either; there will never be a renaissance in demand for buggy whips or coal scuttles, no matter how cheap the cost of manufacture.  

None of this precludes or diminishes the question of fundamental value. Even if you seek growth assets as we do, one should always be asking these questions: what are you paying for a unit of growth, and what is your level of conviction that growth will be achieved? Relative value remains as real today as it ever was, and would rule out the allure of seemingly cheap buggy whip makers, since the growth on offer would be zero, which compares unfavourably to almost anything else. 

“It is not down on any map; true places never are” 

We are not hunting a white whale, nor do we believe that we are on a mission ordained by some higher calling. We seek the same goals as we ever did, and are far more likely to be found searching for southern right whales, on the grounds they are easy to catch, than pursuing some flight of fancy.  

Ahab was good at his job and a successful, if embittered man. Unfortunately, he lost sight of what that job was, and became diverted by something else entirely. We have not forgotten what the mission is, nor have we turned back, even if the sailing is very rough.  

Readers can decide for themselves which of three factors outlined above is most likely to be at play in the current market conditions, or the extent to which all three have some role to play. We think that fickle market fashion is the predominant issue, along with some over-interpretation of the financing backdrop.  

The latter should revert over time, as the failure of the secondary funding marketplace does not arise. The former should also revert to normal, but the timing of that is much harder to predict; it could unwind as rapidly as it appeared, like a squall. Sometimes, you just have to trust in the process.  

We always appreciate the opportunity to interact with our investors directly and you can submit questions regarding the Trust at any time via:  

As ever, we will endeavour to respond in a timely fashion and we thank you for your continued support during these volatile months.  

Paul Major and Brett Darke