Background and Rationale
Drug, biotech, and research-based spec pharma stocks tend to outperform their peers in the periods preceding and following the anticipated approval of major new branded products. The rate of relative performance is reasonably constant across the period from the date of new product filing until the date of scheduled regulatory action (generally the ‘PDUFA’[1] date); however negative surprises tend to crowd in the period immediately (+/- 45d) prior to the PDUFA date. Similarly, the rate of relative performance following the regulatory action tends to be fairly consistent for the first year or so, with the exception of concentrated risks in the days immediately following the regulatory action
To capture relative performance before and after regulatory actions, without being unduly exposed to the risks concentrated immediately before and after the PDUFA date, we developed a simple set of rules for buying and selling stocks with pending or recent regulatory decisions on major new products; these rules are summarized in Appendix 5
We’ve established three overlapping rules-based portfolios of companies with pending product approvals; the portfolios vary only by the definition of what constitutes a major new product. In all cases the new product must be a new chemical or new biological entity (NCE/NBE); line extensions or derivatives of previously approved drugs are excluded. Each portfolio then consists of NCE/NBE products crossing any (or all) of three sales potential ‘thresholds’: products whose out-year[2] forecasts account for at least 1%, 5%, or 20% of total company sales. The ‘1% portfolio’ includes all names having a major new product that accounts for at least 1% of out-year sales, the ‘5% portfolio’ includes all names having a major new product that accounts for at least 5% of out-year sales, and so on. The portfolios are overlapping; all of the 20% names are in the 5% portfolio, and all of the 5% names are in the 1% portfolio. In all portfolios, companies are held on an equally weighted basis. If a company has more than one product that qualifies it for inclusion in a given portfolio, the company is held at a correspondingly greater weight
Any of the three (1%, 5%, 20%) portfolios can be further divided into those containing only names whose major products have yet to reach their PDUFA date (‘pre-PDUFA’), those containing only names whose major products have passed their PDUFA date (‘post-PDUFA’), and portfolios containing all pre- and post-PDUFA names (‘combined rules’ portfolio)
Results
Exhibits 1 thru 3 show how the risk / return of our combined rules, pre-PDUFA, and post-PDUFA portfolios compare to the risk / return characteristics of the DRG, BTK, S&P 500, and our own ‘innovator index’[3]. The period examined is November 2011 to present. In the combined rules portfolios (Exhibit 1), the 1% combined rules portfolio produced 55% absolute returns as compared to 38% absolute returns for the innovator index, but at the same level of risk (as implied by the standard deviation of returns, x-axis). The 5% and 20% combined rules portfolios produced greater returns than the 1% combined rules portfolio and all benchmarks, but at substantially higher risks. Across the period analyzed, the 5% combined rules portfolio is superior to the 20% combined rules portfolio; both have similar returns, but the 20% combined rules portfolio had substantially higher risks
The pre-PDUFA portfolio (Exhibit 2) was superior to the combined rules portfolio across the period analyzed, which clearly implies the post-PDUFA portfolio (Exhibit 3) was a significant drag on performance. The 1% pre-PDUFA portfolio produced greater returns (53%) than the innovator index (38%), but at substantially lower risk (12% s.d. of returns for the 1% pre-PDUFA portfolio v. 15% s.d. for the innovator index). The 5% and 20% pre-PDUFA portfolios produced greater returns than the 1% pre-PDUFA portfolio and all benchmarks. The 5% pre-PDUFA portfolio was superior to the 20% pre-PDUFA portfolio, producing nearly identical returns at substantially lower risk (24% s.d. of returns for the 5% pre-PDUFA portfolio, v. 36% s.d. for the 20% pre-PDUFA portfolio)
As was mentioned the post-PDUFA portfolios dragged down the performance of the combined rules portfolio (Exhibit 3). All three (1%, 5%, 20%) post-PDUFA portfolios produced either comparable returns at substantially higher risk (the 1% post-PDUFA portfolio) or lower returns at substantially higher risk (the 5% and 20% post-PDUFA portfolios)
Discussion
The relative performance (v. the innovator index, y-axis) of all closed pre-PDUFA positions (1%, 5%, and 20%) over time (x-axis; oldest purchase date at left and most recent at right) is summarized in Exhibit 4a. Just less than half (46.0%) of positions outperformed the index in the largest (1%) portfolio; however because the average relative performance (31.8%) of outperforming positions exceeded the average relative negative performance (-19.6%) of underperforming positions, the overall pre-PDUFA portfolio outperformed. The table in Exhibit 4b identifies the positions with ≥50% relative performance (positive or negative); and the table in Exhibit 4c further summarizes the performance of closed pre-PDUFA positions by sales threshold (i.e. the 1%, 5%, and 20% pre-PDUFA portfolios)
Exhibit 5a displays the relative performance (v. the innovator index, y-axis) of all closed post-PDUFA positions (1%, 5%, and 20%) over time (x-axis; oldest purchased date at left and most recent at right). In contrast to the pre-PDUFA portfolio, most post-PDUFA positions (73.1%) outperformed the innovator index; however the minority of positions that underperformed did so by a very large margin (27.7% average underperformance, as compared to only 9.2% average relative gains for outperforming positions). The table in Exhibit 5b identifies the positions with ≥40% relative performance (positive or negative); and the table in Exhibit 5c further summarizes the performance of closed post-PDUFA positions by sales threshold
Since inception (November 2011) the 1% and 5% pre-PDUFA portfolios have plainly outperformed the comparator indices; the 1% pre-PDUFA portfolio offered greater returns at less risk than the comparator innovator index, and the 5% pre-PDUFA portfolio offered a reasonably efficient option for added returns at added risks as compared to the 1% pre-PDUFA portfolio. All other portfolios were inferior to the 1% and 5% pre-PDUFA portfolios, and all post-PDUFA portfolios were inferior to the comparator indices as well
The negative relative performance in the post-PDUFA portfolios is a departure from the observed historic (1996 – 2011) performance history that forms the basis for the post-PDUFA rule, and can be attributed to a handful of positions with large losses, all of which hit the 5% post-PDUFA portfolio and most of which hit the 20% post-PDUFA portfolio. The 1% post-PDUFA portfolio, despite having none of these large losses, still failed to beat the comparator indices on a risk-adjusted basis; the 1% post-PDUFA portfolio produced absolute returns on par with the BTK, but at more than twice the s.d. of returns (Exhibit 3, again). We’ll continue to track the performance of the theoretical post-PDUFA portfolios, but we no longer recommend holding the post-PDUFA names
All of the pre-PDUFA portfolios outperformed the comparator indices; however the 20% pre-PDUFA portfolio produced returns on par with the 5% pre-PDUFA portfolio, only at much higher risk. The reasons for greater risks in the 20% portfolios are obvious; these portfolios tend to have fewer positions than the 1% and 5% portfolios, and the names held tend to be more heavily reliant on the pending new product(s). Since inception the marginal risks in the 20% pre-PDUFA portfolio plainly are not warranted as there is no corresponding marginal gain in performance. Accordingly we’ll continue to track a theoretical 20% pre-PDUFA portfolio, but do not recommend such a concentrated set of positions. Instead, we recommend either the 1% or 5% pre-PDUFA portfolios, depending on risk tolerance (Exhibit 2, again)
Appendix 1: Current Portfolio
Appendix 2: Closed Positions
Appendix 2: Closed Positions (cont.)
Appendix 3: Current NDA/BLA Pipeline Sorted by Days Until PDUFA
Appendix 3: Current NDA/BLA Pipeline Sorted by Days Until PDUFA (cont.)
Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First)
Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)
Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)
Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)
Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)
Appendix 4: Current Phase 3 Pipeline Sorted by Date of Projected Filing (Soonest First) (cont.)
Appendix 5: Rules for buying and selling
Pre-PDUFA Rule
In the pre-PDUFA portfolios, stocks are included on the date a qualifying product is submitted to FDA for approval, and holdings are equally weighted. In the pre-PDUFA period extending from submission to 45 days preceding the scheduled regulatory action, the stocks are held long unless a final regulatory action is announced, or the scheduled regulatory action is indefinitely postponed; in either of these events the position is sold. In the period 45 days prior to the scheduled action date and the scheduled action itself, the stock is held long until the earlier of a final regulatory action, an indefinite postponement of the scheduled action date, a relative gain of more than a threshold magnitude[4], or the scheduled action date, at which point the position is sold
Post-PDUFA Rule
Stocks tend to outperform their peers following final regulatory actions on major products (both approvals and failures); however timing of entry is crucial. Product approvals tend to lead to periods of relative outperformance; presumably the market has tended to under-appreciate the revenue and/or earnings gains driven by newly approved products. Product rejections also tend to lead to relative outperformance; we interpret this as simple mean-reversion of stocks that were over-sold in the wake of products failing to gain regulatory approval. In both cases, purchasing on or shortly after a regulatory action tends to lead to relative underperformance, whereas purchasing within 30 days following the regulatory action tends to lead to relative outperformance
The post-PDUFA portfolio consists of equally weighted stocks having received a final regulatory action on products whose consensus forecasts represent (or in the case of rejections, represented) at least 1, 5, or 20 percent of the consensus forecast for the entire company. Stocks are included on the earlier of a relative share price reaction (versus the innovator index) of a threshold magnitude[5], or a date 30 days after the final regulatory action. The pre-30 day relative share price reaction trigger is agnostic to the ‘direction’ of relative performance; the purpose of the rule is simply to indicate whether the stock appears to have had its ‘full’ reaction – positive or negative – to the regulatory action, as buying ahead of or during the share price reaction to a final regulatory decision appears to be value-destroying. Stocks included in the post-PDUFA portfolios are held until the earlier of a relative gain above a threshold percentage[6], or a period 365 days following the final regulatory decision
[1] ^ For new product sponsors paying fees under the Prescription Drug User Fee Act, the Food and Drug Administration (FDA) is required to reach a regulatory decision – with some exceptions – in a set time frame. Thus the date on which a final regulatory action is due is referred to as the ‘PDUFA date’
[2] ^ Years +2 through +4
[3] ^ An equally weighted index of all therapeutics stocks eligible for inclusion in these portfolios
[4] ^ Defined as total relative outperformance of >6% AND >3% outperformance over a 15-day period
[5] ^ Defined as >+/-3% relative performance over a 5-day period
[6] ^ Defined as total relative outperformance of >6%
