Geoffrey Hsu, portfolio manager of The Biotech Growth Trust, argues that while investment is flowing back into biotechnology, funds have become more discerning.
The biotechnology sector has staged a notable recovery over the past year, with investment flowing back into the sector. An important development for investors looking to predict future trends, however, is not the scale of that rebound, but what is now driving it. What we are seeing is a shift from a broad, valuation-led recovery to a more selective phase, where performance is increasingly tied to underlying scientific progress, clinical execution and strategic relevance.
A key feature of this transition is the accelerating pace of innovation across a number of high-impact therapeutic areas. Capital is concentrated in advanced modalities such as gene therapy, antibody-drug conjugates, oligonucleotide-based medicines and next-generation immuno-oncology approaches. These platforms are opening up new ways to target disease biology with greater precision and efficacy, particularly in oncology, which remains the largest and most dynamic area of opportunity.
Innovation intensity
Indeed, artificial intelligence is increasingly accelerating progress across the biotech value chain, particularly in drug discovery and clinical development. AI-driven platforms are improving the identification of novel drug targets, optimising molecular design and helping prioritise the most promising candidates earlier in the process. This has the potential to reduce both the cost and time associated with bringing new therapies to market, addressing one of the long-standing structural challenges facing the sector.
This growing innovation intensity is also shaping where pharmaceutical companies are directing their attention. Large pharma is increasingly reliant on external innovation to replenish pipelines, particularly in the face of looming patent expiries. As a result, smaller and mid-cap biotech companies developing differentiated science in these high-growth areas have become central to the industry’s r&d ecosystem.
This dynamic is clearly reflected in recent m&a activity across the sector. The news that GSK has agreed to acquire Nuvalent for $10.6 billion (£7.9 billion), representing a 40% premium to the company’s closing price at the time of the announcement, highlights both the strategic value placed on high-quality biotech assets and the willingness of large pharmaceutical companies to pay up for innovative companies. Nuvalent is focused on developing targeted therapies for cancer, with two lead drugs under review for the treatment of non-small cell lung cancer in patients with specific genetic mutations, illustrating the type of precision, mechanism-driven science now commanding significant strategic interest. Rather than relying solely on internal r&d, pharma is increasingly using acquisitions to secure cutting-edge capabilities in areas such as targeted oncology, reinforcing the role of smaller biotech companies as a critical source of pipeline renewal.
At the same time, the global nature of biotech innovation continues to expand. China is playing an increasingly important role, both as a source of novel therapies and as a partner in global development strategies. Faster and lower-cost r&d, alongside improving scientific capabilities, are driving its competitiveness and enabling a growing number of cross-border licensing and investment deals. A McKinsey report from earlier this year highlighted that trial recruitment often runs two to five times faster than US and EU benchmarks in late development.
Precipice of the recovery
Despite these positive structural trends, we are still at the precipice of the recovery. Many early-stage businesses continue to trade below historical valuation levels. For investors, this creates a more nuanced opportunity set. Broad exposure to the sector is no longer sufficient; returns are increasingly driven by the ability to identify companies with differentiated science, strong development pathways and access to capital. Biotech has always been characterised by high dispersion and binary outcomes, but as valuations normalise, the market is once again distinguishing more clearly between assets based on their probability of success.
Within this environment, as investment managers, our approach remains focused on identifying the most promising innovations at an early stage. Approximately two-thirds of our portfolio is invested in pre-revenue companies, with a strong bias towards small- and mid-cap innovators where we see the greatest potential for value creation as scientific progress translates into clinical and commercial traction.
Looking ahead, the sector’s trajectory will continue to be shaped by three forces: sustained scientific innovation, strong demand from pharmaceutical companies for acquiring these companies and a more stable macroeconomic backdrop. Together, these factors provide a supportive environment, even if returns are likely to be more selective and fundamentals-driven than in the early stages of the recovery.
The key point is that biotech’s recovery is becoming more discerning. For investors, that marks a shift from a market driven by re-rating to one defined by delivery.
