Taming the crowd for better biotech investing?

March 12, 2014

Biotech investment has rarely been hotter. After a decade of anemic public markets for startups, more than 70 life sciences companies have successfully gone public since the start of last year, raising nearly $2 billion in the process.

In analyzing how we got here, pundits inevitably offer the benefits of a strong overall stock market, spillover investing from huge profits made in technology or the positive impact of the Jobs Act for putting wind back into the sails of biotech investments.

But what if the answer is more primal? Or is something new and innovative contributing?

Pundits of rationality, neuro-economics and decision-making suggest that social context plays a huge role in human thought and choice behavior – including choices about where to invest your money. While each of us believes that we are masters of our own destiny, most of the latest research suggests that we are more like lemmings than independent thinkers, with the crowd we travel in dramatically influencing what we believe and what we do … including how we invest.

Today the inferred “wisdom” of crowds has been morphed into mass markets of crowd funding. Sites like Kickstarter, Indiegogo, Crowdfunder, AngelList and Quirky have pushed more than $5 billion into new product concepts over the past year – or more than double that raised in the best biotech IPO market in decades.

But what does this portend for biotech, with its famously difficult, time-consuming and costly path to product approval? Is the current favorable view for biotech based on fundamentals, or is it more a function of group-think that has driven investor interest so high?

At one level, it is hard to argue with the rational point that the Jobs Act has enabled more investors to take a close eye at biotech, creating a more startup-friendly approach to certain disclosure requirements and giving biotech companies more leeway in reaching out to investors ahead of an IPO; innovating by simplifying. By this logic, the Jobs Act helped eliminate a real stumbling block that kept some on the investment sidelines; namely, that people just didn’t understand the complex investment thesis being presented. With more time and transparency to understand a company’s fundamental they could marshal a rational argument in favor of getting in early, rather than waiting to see how things pan out.

But once they are in, how long will this rationality last? It’s early days still for these 70 new public biotech companies, and there are clearly still hurdles ahead for the inventions they are advancing. Will the wisdom of the crowd make them more tolerant of risk and failure than they have been in the past? A reading of history makes us cautious.

One of the more innovative ideas of recent is MIT economist Andy Lo’s proposal to create a cancer research “megafund”–$30 billion or so–which would allow a large pool of investors to balance risk at a scale not currently possible by traditional means. He believes this pooling approach could be better suited to cancer research than it was for diversely bundled mortgage-backed securities, and he may be right. From a scientific perspective, despite the inevitable bumps ahead, the overall trend is definitely in favor of precision medicine, and more cures reaching patients. Although the mechanics to aggregate the initial early drug candidate asset pool (n~200) have yet to be resolved, by balancing risk more carefully, such a fund would take investors out of the game of picking winners, which may create a more stable source of funds for innovators.

If we can tap into the collective desire of for “crowd-funded” and related “customer-funded” innovation while simultaneously tempering our instinctual proclivity for knee-jerk reaction to failure, we might bring both new wisdom and significant new pools of capital into the system.