Investment Case for IBBJ: Defiance Nasdaq Junior Biotechnology ETF

Investment Case for IBBJ: Defiance Nasdaq Junior Biotechnology ETF

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Pharma and biotech are often safe havens for investors in turbulent economic times. But that’s not the reason that this sector suggests great potential moving into 2021. A number of factors, both macro-economic and sector-specific have coalesced to provide strong growth indicators. Defiance’s IBBJ Junior Biotech ETF offers low-cost, diversified exposure to this dynamic space, with its strong R&D and M&A elements and conducive regulatory environment.

This investment case will explore:

  1. Why pharma and biotech?
  2. Why junior stocks?
  3. Why IBBJ?

Why pharma and biotech?

The global pharmaceutical market has experienced significant growth in recent years. It was valued at about US$1.25 trillion at the end of 2019, a significant increase from its US$390 billion 2001 evaluation.1 Research and development in this industry also rose from $129 billion in 2010 to $179 billion by 2018.2 According to a report from IQVIA, the industry has experienced a 3 percent compound annual growth rate (CAGR) since 2014.3

Biotechnology’s performance stood out in 2020. Termed “the greatest year ever for the biopharma industry,” venture capital remained high: over $26bn raised (the prior high was $19 bn in 2018).4 One of these deals was in September, when Gilead Sciences purchased Immunomedics for $21 bn, a 108% premium; which was six months after Gilead’s $5bn purchase of Forty Seven.5 And these are just the tip of the iceberg.

Growth in this sector is not dependent on a postvaccine spending boom, on employment figures or other traditional business metrics. R&D lies at the core of value-determination in biotech, which is largely insulated from short term economic slumps by the insurance system that pays for medicines. This means that data and innovation are perhaps better indicators of future growth than in other sectors. Take Inovio for example. Its R&D costs in 2019 totaled $95m, far greater than its revenues of $4m. However, by mid-2020 the company’s market cap was $4.3bn – its investment in DNA vaccine technology was paying off as Inovio found itself positioned among the leaders in Covid-19 vaccine research. And while internal sector forces continue to drive growth, the macro-economic
context also contributes to bullish estimations. Very low interest rates combined with massive government support for small and mid-sized
companies leaves capital chasing opportunities. High investor demand, plenty of financial capacity and limited assets have been viewed by PwC as offering the potential conditions for market deals.6 A widespread sense that science and technology offer the way out of the pandemic have also contributed to positivity around this sector. FDA approvals and pre-approvals were already up before the pandemic, and the need to find a vaccine has only heightened awareness of the need to expediate the
regulatory process of medical innovation.

Why junior stocks?

While biotech and pharma are both economically and politically on the up, what makes the junior side (under $5bn market cap) so exciting looking ahead to 2021? Even before Covid-19, small-cap biotech companies had the advantage of a Food and Drug Administration more receptive to new cutting-edge and rare-disease therapies. They were also encouraged by increased patient lobbying and greater willingness by insurers to pay for treatments.7 However the sub-sector continued to strengthen, largely due to the effects of the pandemic as well as natural sector development.

A number of large firms are facing a patent cliff, whereby their exclusive rights to manufacture certain widely-used drugs are coming to an end. Their revenue stream is about to face serious competition and they need to develop other sources. Combined with their large accumulated funds (the ten largest biotech and pharmaceutical companies in the S&P 500 had an average cash stockpile of $10.7 billion as of mid-June, 20208), the stage is ready for extensive M&A activity and valuation leaps for the smaller companies.

Firms like Pacific Biosciences of California, which has developed Single Molecule and Real-Time (SMRT) technology to enable real-time analysis of biomolecules with single molecule resolution. Or FATE, which researches and develops therapies to repair and regenerate body tissues with the help of stem cells, and announced its intention to IPO in January 2021.9 Such junior stocks are even a potential target for global biopharmas looking for assets in the US. They have become more attractive due to the extensive innovation in the country and the lower tax penalties for incoming firms.

Whether for cancer research, or a vaccine or treatment for Covid-19, there is confidence that the strong demand side in these industries, combined with the drive towards innovation and research, will continue to support growth and development. Government regulation and policies also appear to prioritize these sectors, whose centrality to the wider economy has only been highlighted by the global corona pandemic.

Why IBBJ?

With committed R&D budgets, small cap biotechs are primed for innovation. The wider economic context suggests that there will be some consolidation, as large companies look for new income flows and
smaller firms band together in uncertain economic times. All of these movements can bring growth and profit to investors, but it is not always possible to predict the winners. This is where a weighted, index-based fund can offer low-cost, diversified yet targeted exposure, while seeking to insulate against big swings in individual stocks.

IBBJ, the Defiance Nasdaq Junior Biotechnology ETF seeks to replicate the performance of the Nasdaq Junior Biotechnology Index (before fees and expenses). It offers investors exposure to smallcap “junior” companies, under $5 billion of market capitalization, classified as either biotechnology or pharmaceutical according to the Industry Classification Benchmark (ICB). IBBJ provides exposure to companies engaged in research and development, the sale or licensing of biological substances for the purposes of drug discovery and diagnostic development; and pharmaceutical manufacturers of prescription or over-the counter drugs, including vaccines and development and manufacturing companies.10

Initial R&D stats from the companies captured in the Junior Biotechnology Index indicate a thirst for growth and a pharma business model that prizes innovation before sales. For 2020, companies in the Index totaled nearly $20 bn on R&D, equivalent to 63% of their revenue. Some of these companies do not yet have any revenue, and of those companies who did some level of sales, 73 (the equivalent of 40% of the index) reported R&D expenses higher than their revenues.11 The scope for M&A and major scientific breakthroughs is there. IBBJ is rebalanced every quarter to ensure that the maximum weight of any one security does not exceed 8%.

About Defiance

Founded in 2018, Defiance ETFs is an exchange-traded funds (ETFs) sponsor and registered investment advisor focused on next generation investing. Our suite of rules-based ETFs allows retail and institutional investors to express a targeted view on dynamic sub-sectors that are leading the way in disruptive innovations.

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1 “Revenue of the worldwide pharmaceutical market from 2001 to 2019,” Statista,
https://www.statista.com/statistics/263102/pharmaceutical-market-worldwide-revenue-since-2001/

2 “Total global spending on pharmaceutical research and development from 2010 to 2024,” Statista,
https://www.statista.com/statistics/309466/global-r-and-d-expenditure-for-pharmaceuticals/

3 “Why Consider Investing in Pharmaceutical Stocks?” Melissa Pistilli, Investing News Network, June 11, 2020
https://investingnews.com/daily/life-science-investing/pharmaceutical-investing/investing-in-pharmaceutical-stocks/

4 “The Biotech Paradox Of 2020: A Year In Review,” Bruce Booth, January 4, 2021.
https://www.forbes.com/sites/brucebooth/2021/01/04/the-biotech-paradox-of-2020-a-year-in-review/?sh=a5abee43b3ac

5 “2021 forecast: M&A poised to rebound in 2021, fueled by pharma’s $1.47T in deal-making firepower: analysts,” Arlene Weintraub, December 22, 2020.
https://www.fiercepharma.com/pharma/m-a-poised-to-rebound-2021-as-pharma-sits-1-47t-deployable-capital-analysts-predict

6 “Global M&A Industry Trends in Health Industries,” PwC, https://www.pwc.com/gx/en/services/deals/trends/health-industries.html