Picking season

Why small- and mid-cap biotechs will remain in vogue in 2Q18


Macroeconomic risks, surging volatility and a tail-off in the M&A market since January have done little to change the buyside’s strategy of overweighting small- and mid-cap biotechs.

In fact, the 12 investors who spoke to BioCentury are reveling under conditions they say favor stock picking and allow for meaningful alpha generation, or outperformance of the sector benchmarks. Moreover, they expect the conditions to persist at least through the second quarter and perhaps the rest of the year.

The four mega-cap biotechs valued over $50 billion offer a dearth of near-term value catalysts after a litany of self-inflicted wounds depressed sentiment. Investors thus expect the big caps to weigh down the biotech indexes again in 2Q18.

While buysiders said historically depressed multiples could encourage value investors to take a look at the big caps, the consensus is the fundamentals don’t merit a meaningful rotation into these names any time soon.

At the other end of the spectrum, investors see small- and mid-caps as fairly to slightly overvalued on the whole.

The upshot is a continued lack of generalist interest in the space, constraining fund flows and multiple expansion. Meaningful gains in the indexes, even those more heavily weighted to smaller biotechs, are therefore unlikely.

Instead, investors expect company-specific fundamentals to continue to drive performance, creating ample opportunities to pick winners.

Small- and mid-caps have the added tailwind of hoped-for sector consolidation.

While the first quarter saw over $25 billion spent on three sizable public takeouts, overall deal flow was relatively quiet.

But buysiders are betting big cap pharmas and biotechs need to acquire external assets to improve their growth profiles, and have plenty of cash to do so.

Anchored

The buyside’s decision to kick off the year overweighting small- and mid-caps proved to be a smart

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