There is a growing consensus that the “bench-to-bedside” process of translating biomedical research into effective therapeutics is broken. A confluence of factors explains such pessimism but among the most widespread is the sense that the current the drug development business model is flawed. The development of new therapeutics is an expensive, lengthy, and risky process that challenges traditional funding vehicles, which are limited in size, scope, and risk appetite. Moreover, according to a recent study published in Nature Biotechnology (Brady Huggett, Biotech’s wellspring: a survey of the health of the private sector. May 2012), the number of active venture capital funds interested in early stage biotechnology has fallen by over 35% since 2007 and investments in innovative biotechs have gone into a troubling decline. The biomedical industry is in need for alternative models and resources to develop the new and promising biomedical technologies.
Over the last 2 years I have been working with Professor Andrew Lo and Doctor Roger Stein on the design of an alternative model for funding drug development that addresses these issues through the use of “financial engineering”—mathematical and statistical models for structuring and pricing various financial securities to achieve specific objectives.
Our approach involves the creation of Biomedical Megafunds (BMFs) with two components: (1) raising large pools of capital to invest in multiple drug-development programs simultaneously; (2) structuring these pools as combinations of equity and securitized debt in order to access much larger sources of investment capital. By investing in larger and diversified portfolios of drugs the risk is mitigated to the point where debt can be issued to finance part of the drug development costs. The possibility of using debt to finance drug discovery projects offers new possibilities in terms of accessing deep-pocketed investors that have traditionally not invested in this market and, since debt financing is cheaper than the traditional equity like structures, using debt securities also lowers the cost of capital borne by the projects funded through the megafund.
We have constructed an analytical framework for assessing the financial risks and rewards of such a portfolio. We have simulated BMFs that would invest between $5 and $15 billion in drugs for cancer that are in preclinical and clinical phases. The results show that the bond investors in such BMFs would obtain between 5% and 8% per year with a low probability of default and that equity investors would get annual investment returns in the range of 8.9% to 11.4%
BMFs can offer a new research and development model for the biopharma industry. Despite the promising simulation results for oncology compounds, any implementation of a megafund must overcome several practical challenges related to capital raising and deployment, the organizational challenges of managing a large portfolio of drugs and the regulation of BMFs that should strike the right balance between promoting its adoption and preventing the risk for abuse and fraud that may lead to its demise.
The first application of our model has focused on cancer therapeutics. But cancer is just one of a growing number of large-scale challenges confronting modern society that can only be addressed through the sustained collaboration of thousands of highly skilled and dedicated individuals. Financial engineering can facilitate such complex collaborations by providing the right incentives to all stakeholders and the tools to measure and understand the risk return profile of these new assets and investment vehicles.
Jose-Maria Fernandez is a Researcher at the MIT Sloan Laboratory for Financial Engineering; Roger M. Stein, is Managing Director of Research and Academic Relations globally at Moody’s; and Andrew Lo is Professor of Finance and Director, Laboratory for Financial Engineering, MIT Sloan School of Management