Can Derivatives Cure Cancer?

GingerGuy's picture
Rank: Gorilla | banana points 570

This TED Talk by MIT Professor Andrew Lo describes how financial engineering can be used to help cure cancer.

In the video he describes what sounds like an ABS with several tranches that would be open to public investors. This way you could get around the inherent risk of investing in startup biotech companies that are reliant on an upcoming drug test.

He notes that the final drug tests tend to have 2 outcomes:

  • Fail the drug test, 19/20 chance, investment lost
  • Pass the drug test, 1/20 chance, multiples of ROI

The product he is describing is reminiscent of the MBS that were all the rage in the mid 2000's. Different tranches etc.

What do you guys think about using this structure to securitize investing in cancer startups?

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Comments (12)

Most Helpful
Dec 6, 2018

I did an entire graduate thesis on this exact topic. My conclusion was no for 3 main reasons:
1. Institutional investors are not sophisticated or risk-happy enough to invest in these pretty complex multi drug derivative portfolios
2. The due diligence needed for a portfolio of even 100 drugs would be insane and even it was composed of 10-20 phase 1 products you would be making crazy wild valuation guesses
3. Pretty much all successful drugs that came from small companies have been bought or commercialised by big pharma. If you put a drugs's IP or royalty in a derivative a portion goes to investors. Big Pharma will not like a drug that only has 60-70% of the royalties or IP up for grabs. They tend to want almost all of it. If you don't get Big Pharma onboard in todays market you won't have that much success.

PM me if you like, I'm happy to share the original paper with you

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Dec 6, 2018
  1. Not sure what you mean by being "risk-happy." The purpose of these instruments is to reduce risk to the level of any other derivative investment. Plenty of institutions still invest in derivatives of varying risk profiles.
  2. I agree that the valuation of future drugs is the main challenge in this method. But again it's not really that different from other derivatives. Also I believe Lo tries to capture this valuation uncertainty. He mentions it also helps if the drugs are less correlated from a biological perspective, obviously (e.g searching for a cancer drug plus another drug targeting a neurodegenerative disorder vs. two cancer drugs).
  3. Not really sure what you mean here, as I'm pretty sure all Big Pharma cares about (like any other for profit) is risk-adjusted IRR. They would rather have 70% of a big pie than 100% of nothing.

Would be interested in your thesis! I come from an AM background so this idea intrigued me, but maybe I don't understand the nuances of pharma AM.

Dec 6, 2018

I will send it to both you and @LeveredCat"

As for your point I will try to elaborate

  1. By risk I mean the risk of the underlying assets. These assets will be clinical products with very low chances of success. In the early 2000s CS made a product like this from a portfolio of 14 late-stage candidates and only 3 survived by 2011. Granted, the value of the derivative went up because the surviving drugs did very well but now with more complex therapies, more competition and very different reimbursement methods (in particular for the new therapies like gene therapies) your market success may vary. All of these factors make the product quite risky.
  2. If you make a portfolio of 100 cancer drugs (perhaps just in 1-2 cancers) your DD will be easier but realistically only 1-2 will be successful and you have to pray that they become blockbusters. To ensure success you would/should pick the top 50 or so drugs from 20-30 diseases but this would be an absolute shitshow for DD because each disease and disease market has different dynamics. Sure, you can argue that MBS have thousands of mortgages and are a nightmare to look at but they are all based around a standardised market with clearly set parameters. How would you assess the willingness to pay of HTAs in the EU5 for a drug for Progeria or something like that? Considering it has never been done before? DD headache.
  3. You also have to remember that the small biotechs are courting Big Pharma and not the other way around. If there are 100 phase 1 drugs for lung cancer, there may only be a couple of Big Pharma companies ready to spend the $200-300 million to acquire them. If 70-80 of them have a portion of their IP tied up elsewhere, Big Pharma will most likely snob them and aim for the other 20-30 that don't. The other point here is that small biotechs need both money and resources. A derivative can give them all the money they want but it won't give them R&D strategy advice or the ability to access marketing and distribution channels or even engage in payer discussions. Pharma can.
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Dec 11, 2018

I don't buy that VCs, big pharma, etc. can "pick" the early stage drug that will work with more DD. It's random. With this instrument, you don't need to rely on picking, you have a high likelihood of capturing the winners and the large expected value from them given the large number of drugs in the derivative.

Also, big pharma is doing less R&D (given low ROI, again, you can't "pick" the winners) and relying on small biotech. More tech creators increases the need for new financing.

Assuming the winners pay for the losers, I think it makes sense. Why not securitize every single drug? You have 100% chance of capturing the big unicorns

Dec 6, 2018

Of course VC and Big Pharma make assumptions and projections but they don't close their eyes, throw the dart and hope for the best. They have a lot of experience and DD is a pretty standard part of types of deals. I don't know if anyone has managed to study this vs a control group because I'm pretty sure no one would buy a company having done no DD. Instruments like these need DD for two main reasons: 1. If you securitizied everything that moved, the instruments would be in the tens or hundreds of billions of value and no one would buy it. For most investors that would mean putting all their capital into one investment type/industry and that's just not going to happen. 2. Every 3-4 person PhD team with a decent financial backing and a bright idea can get a drug past pre-clinical models into Phase 1. There are literally hundreds of thousands of drugs out there in early stages so even making a product with 1000 of them would require selection.

And not all winners can pay for the losers. If you're AbbVie and your Humira peaked $18 billion in annual sales then you can afford to fuck up some other drugs. But if you're Spark Therapeutics who's Luxturna is expected to peak $300 million by 2022, if any of the other pipeline projects you have tanks, you're fucked.

Casting a wider net forces you to spread your resources thinner and you won't be able to make significant investments. If I gave you $1 billion to spend would you rather conduct proper DD and invest $200 million in 5 ideas or $ 1 million in 1000 ideas? What is a biotech going to do with $1 million? That's not even enough to fully kit out your R&D lab. This is why as we go further you see investments becoming more specialised, not more generalist.

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Dec 11, 2018

Fair. Of course I agree some DD is necessary to check on the tech and team.

But I also think concentration is foolish at such an early stage. Diversification is rational when you have things that can go up 1,000x but losses are capped at 1x.

And when only 1 out of 1,000 drugs make it big, the likelihood of picking them with 5 bets is not so good

Dec 6, 2018

So I've reached my PM limit and can't send PDF files via PM. If you PM me your email I can send it over

Dec 6, 2018

Is there any way I can read your graduate thesis? I'm interested in pharma too but don't have any formal training. It would be good to be informed.

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Dec 6, 2018

So I've reached my PM limit and can't send PDF files via PM. If you PM me your email I can send it over

Dec 6, 2018


Dec 6, 2018

This is why a biotech VC has a portfolio of companies and why investors should diversify, not just place a couple huge bets. Additionally there is more dry powder and deal hunger in biotech right now than at any point in history, meaning any company with a semblance of a good idea and operational knowhow is able to get and maintain funding through clinical trials. This idea seems silly and unnecessary.

Dec 10, 2018