ETF Expert Corner

Biotech Expert Brad Loncar Discusses Sector, ETFs

February 21st, 2017 by ETF Store Staff

Biotech industry expert Brad Loncar discusses his approach to investing in biotech stocks and key current drivers in the sector.  Brad also offers his perspective on broad-based biotech ETFs and explains the index behind the Loncar Cancer Immunotherapy ETF (CNCR).



Transcript

You can listen to our interview with Brad Loncar by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: I'm now very pleased to welcome to the program, Brad Loncar, Head of Loncar Investments. As I mentioned, Brad is a recognized biotech industry expert. He also created the index behind the Loncar Cancer Immunotherapy ETF. Lucky for us, Brad is based right here in Kansas City. Brad, great having you back on the program. Glad you could join us in studio today.

Brad Loncar: It's my pleasure. It's a lot of fun, so thanks for having me.

Nate Geraci: Brad, for listeners who may not have heard you on our program before, let's start by talking about your background. How was it that you came to be involved with biotech investing?

Brad Loncar: I'm a biotech junkie. I run a small family office here in town. I've been doing that full-time for almost 10 years and part time my whole life. I've just always loved science. I was the young science fair kid, and also investing. My first job out of college was at Franklin Templeton Investments. I've always just enjoyed combining the two. I think that biotech, when it goes well, is the most rewarding thing to invest in for the reasons you mentioned at the beginning of the show. This is important stuff and this affects everybody and is important for society. It's a lot of fun to invest in, especially with all the innovation that's going on right now.

Nate Geraci: I think for some investors, biotech can sound a bit scary or intimidating. For people who may be unfamiliar with the biotech sector, what types of companies are we talking about here? Can you give us an idea as to what some of these companies do? Are these just drug companies or does this include other areas as well?

Brad Loncar: There's actually a traditional definition of the word "Biotech" which is companies that make what we call biologics or therapies that come from living organisms. Really, that definition is blurred. When we say biotech today, I think most people think of companies that are developing drugs. You think of large pharmaceutical companies, so people still call the Pfizer’s of the world, "Pharma," and I think anything a little more edgy and innovative than that is what we call biotech. It's really anybody making it in the drug development business these days.

Nate Geraci: You mentioned that you manage a family fund, which I know includes individual biotech stocks. Just high level, what's your overall investment philosophy when it comes to biotech? Are you more tactical? Are you more strategic? How do you approach the space?

Brad Loncar: I'm a long-term investor. The thing that is really my guiding principle is you have to invest in the things that deliver the most value to patients. This industry exists for a specific reason: to develop new medicines that really matter for society. You have to separate out incremental improvements from big advances. I try to invest in those things that have the biggest impact on patients' lives.

Jason Lank: Brad, many investors are familiar with the Morningstar Style Box. Growth, value, small, medium, large. Does that apply in this industry? Intuition tells me these are growth companies you're looking at. Is there a value company? Is my opinion wrong on that? How should investors view it from that lens?

Brad Loncar: It's growth. Frankly, it's also risky. You can't really assign a traditional investment metric to a biotech company. People are used to PE ratios and things. Well, most drug developers don't have earnings. They're purely developmental. You really have to be somebody like me who eats, sleeps, and breathes this because you have to focus on the science. That's the most important thing when investing in these companies. You have to figure out which companies have the best science, and try to prescribe your own percentage likelihood that they'll succeed and actually develop a drug one day. A lot of financial metrics are out the window when you do this type of investing.

Jason Lank: That was my next question. The traditional metrics that many investors use to evaluate a tech company or a Proctor & Gamble, home service company, any of those broad based companies. Those don't necessarily apply?

Brad Loncar: The way that we look at them is we do discounted cash flow analysis for these companies. The real difference maker in this industry is you have to assign probability of success, which really changes what your ultimate end value turns up being for these stocks. You really have to dig down deep into the science and likelihood that these drugs reach the market, to really be able to prescribe a fair market value today. It's a lot different than your traditional companies that already have products and revenue.

Nate Geraci: Brad, let's talk about that a little bit more. You mentioned that you like to find companies that are making big leaps forward as opposed to incremental improvements. As we look at what may make for a good investment opportunity in biotech, I think it can be difficult because there are a lot of smaller startup companies that attempt to come to market with new drugs. Sometimes these startups aren't always on the up and up. Sometimes they're not properly capitalized. Then, of course, you do have the very large, established players in the space. How do you sift through all of these different opportunities?

Brad Loncar: You just have to be immersed in it and to really follow the sector closely. You bring up a good point, which is that for the last five or six years, a lot of companies in this industry sadly had been making money doing artificial things. You've seen inversions and price increases and financial engineering and that's all coming to an end. You've seen the negative headlines in the news about all of those things. Those companies have been exposed. This industry has to get back to basics. As an investor, you have to get back to basics too, and try to only invest in those companies that are really developing meaningful things.

Jason Lank: Brad, something that fascinates me is how a company gets started. Let's suppose you're a bright young physician or researcher and you discovered a molecule that you think could have some amazing benefits to society and healthcare. Where do you go from that point to I can go down to Rite-Aid and pick up the prescription? That's a long way. How does it work?

Brad Loncar: It's a long road. Biotech fortunately has a great venture capital community that helps entrepreneurs get off the ground. One thing fortunately that's changing a lot in this industry, especially in certain areas like oncology that I focus on, you always hear horror stories about how long does it take to develop a drug, and they'll say 10 years, and a couple billion dollars. With the way that certain technologies are improving now, we're getting stronger signals early on in the development process. You'll see a strong signal in a phase one trial, maybe unlike we would have seen five or 10 years ago. Fortunately in a lot of areas, that 10 years is being shortened. It's not as daunting as it used to be. It just comes down to really being an entrepreneur and hustling, just like any other industry. If you have a good idea, you've got to take it to the VC crowd first, and then try to have some data that proves your concept. Then you can take it public and go from there.

Jason Lank: You used a term I'd like you to clarify, it's a phase one trial. Briefly speak to that. Secondly, if you would expand on the regulatory environment we live in, the 10 year process. That's outrageous to bring a drug and help people save lives. What's going on with the current administration perhaps even, with regulatory changes that may be upcoming?

Brad Loncar: On the regulatory side, a lot of positive things have happened recently. President Obama signed something in December called The 21st Century Cures Act that reforms the FDA and speeds up some approvals. We've already had that in past years with something called The Orphan Drug Act. Also, there's something now called Breakthrough Therapy Designation that's trying to speed up approvals. The FDA is starting to approve drugs based on what we call biomarkers. You might not know if a drug works for sure or not, but you can get a signal off of a biomarker that maybe points you in that direction. We're starting to approve things sooner based off of those biomarkers than we used to. In terms of your question about what is a phase one study, drugs are usually developed in three phases. There's phase one, phase two, phase three, and then you submit it for approval. In phase one, it's the very first time that you're testing a drug in human beings. You're not necessarily trying to find out if the drug works or not, you're just trying to prove if it's safe. You're also trying to establish the dose that you'll take to that phase two and phase three trial. It's the very first point that you test something in humans.

Nate Geraci: Brad, I saw a statistic that 90% of new drugs fail to obtain FDA approval. Is that an accurate stat?

Brad Loncar: It is. It's improving a little bit because science in general is improving and, as I mentioned, we're seeing stronger signals earlier in the development process than we used to for sure, and that just illustrates how risky this sector is and why you need to be diversified. Even the best investors of all time in this sector, they're not hitting home runs every time. This is a very difficult business. You have to spread your bets and to be well diversified if you're going to play in biotech. The biggest mistake that investors make is putting all of their eggs in one biotech stock. That's truly in most cases, the riskiest thing you can do in the stock market. You have to be super careful and try to be much, much more broad and diversified than just placing a few bets.

Nate Geraci: Given how critical FDA approval is, I'm just curious, is insider info an issue at all in this industry?

Brad Loncar: Sadly, yes. There's usually three or four cases a year where somebody at a company gave a tip to their uncle or in fact there was even a story a few months ago about somebody at the FDA passing along information. Biotech is the industry where information is most asymmetrical. These companies and regulators have all the information, and you as an investor are basing your decisions off of what they're telling you. Yes. Bad things happen, unfortunately in biotech. Like anything else, that's a very small fraction of what's going on. The vast majority of people in this industry, and of course at the FDA, are good people trying to do the right thing.

Nate Geraci: Again, we're joined in studio today by Brad Loncar, Head of Loncar Investments. Brad is also a biotech industry expert. Brad, let's talk about the current biotech landscape and perhaps your outlook moving forward. As a whole, biotech stocks have started the year on a rather strong note, they're up over 10% year to date, broadly speaking. What are some of the biggest drivers in biotech right now? What are maybe some potential drivers moving forward?

Brad Loncar: I think there's three reasons why we're off to a good start like this. The first, last year was just a rough year. Last year was one of biotech’s worst years in almost 10 years. I think there was a lot of tax loss selling heading into the very end of the year. Part of this, quite frankly, is a little bit of a bump off of a really rough end to the year. On the positive side, I mentioned in December that 21st Century Cures Act was passed. The reason biotech was so difficult in 2016 is with the election going on, you had politicians just bashing this sector every single day. One of the things we're hoping for is that once the election passed, that you can pretty much say anything on the stump, but putting things into reality is a different story. Ever since then, the fundamental news coming out of this sector has been positive. The 21st Century Cures Act was very positive and was very good for innovation and reforming the FDA. Another thing that happened a few weeks ago - and biotech stocks have kind of been off to the races ever since then - the pharmaceutical CEOs met with President Trump at the White House. Again, the history of this sector for the last year or so has just been bashing and dragging the entire sector through the mud. That's really a shame because there have been some bad actors who've taken advantage of our system. Most companies and most people in this sector are good people trying to do the right thing. That meeting at the White House was very positive. The President mentioned that he's not happy with drug prices, but he also acknowledged what an innovative and important sector this is for our country. It came across as very positive. We're all kind of hoping that we've turned the corner from bashing this industry to all of us working together to be the solution and understanding that this is an important sector for our country and our economy. That really came through out of that meeting. I think people feel like the environment is getting better again for these companies.

Nate Geraci: What about generic drugs? Do you consider generic drugs a risk to some of the established companies that are out there?

Brad Loncar: Yes and No. There's a big thing now called biosimilar that I would keep an eye on. Everyone's heard of generic drugs. Well for these biologics, the types of drugs that Amgen and Genentech and a lot of these famous biotech companies came with, revolutionized. There was never generic drugs because since they're made by living organisms, it was unclear if you could say that a generic was exactly the same as what it used to be. Now we have this concept called biosimilar. For the first time, biologics are having generics. That's being approved by the FDA for the first time. That's something to watch that's going to change this sector quite significantly. A lot of the biotech companies themselves are getting into it. Amgen has five biosimilars they're developing. I don't think it's a threat. I think it's a good thing, but it's certainly a term to familiarize yourself with because we're going to be hearing a lot more of it over the next four or five years.

Jason Lank: Brad, if I'm a pharmaceutical CEO and I've got to decide what kind of drugs to pursue, what are some of the thinking points there? Am I looking for a molecule that I can sell the most to make the most money? Am I looking to cure the most patients? What are some of those factors on that need? Then also, let's set those rare, rare medical conditions where there may be a thousand people in the United States. I don't know how a drug could be developed profitably for that small niche. How do those drugs get discovered and come to market?

Brad Loncar: I can tell you what my guiding principle would be if I was a pharmaceutical or biotech CEO. I would focus on things that are unmet needs. Conditions for which there aren't already good therapies. What you're describing, what is profitable has changed a lot. It used to be just big conditions like heart disease and cancer were profitable. That changed five or ten years ago with the orphan drug designation. There's a corner of biotech called rare diseases. Even diseases where there's only a few hundred or a few thousand patients in the entire country are now profitable. There's a company called BioMarin that focuses on that, and Sarepta is another one. Because companies are able to charge high prices for drugs like that and payers are willing to pay them because it's just a few hundred or a few thousand patients, and the government incentives are helping that corner of biotech as well, you can actually make a lot of money off of very rare conditions. That's new as of five or ten years ago. It used to be that nobody went after those conditions. Since the market is kind of helping out and since the government incentivized drug makers to go after those, that's a real big business within biotech today.

Brad, obviously you spend a lot of time evaluating individual biotech stocks, but I do want to turn our conversation towards ETFs. According to ETF.com, right now there are 17 biotech ETFs on the market. The two largest by far are the iShares NASDAQ Biotechnology ETF, ticker symbol IBB, and the SPDR S&P Biotech ETF, ticker symbol XBI. There's also the First Trust NYSE Arca Biotech ETF, among others. I'm curious, how effective do you think these ETFs are at capturing opportunities in the biotech space? Obviously, you developed a biotech ETF, we'll talk about that here in a moment. You're clearly a proponent of ETFs. What do you view as the potential advantages and maybe disadvantages of using ETFs to play biotech?

Brad Loncar: You mentioned the two largest are the IBB and the XBI. I think it's really important for people to know how those are weighted. That's one huge differentiator. The IBB has almost 180 holdings. Believe it or not, five holdings make up over 40% of that product. It's like Amgen, Gilead, and all the big biotech companies that we know. Then the remaining 175 or so are 50 or so percent. That product is dominated by five large holdings and a lot of people don't know how much exposure they're getting to just five companies in that. The XBI has an equal weighting strategy. For that reason, it's a lot more volatile. It's important to know that right off the bat. I personally think those products are a little confusing because it's like you asked at the beginning of the show, well what is biotech? Those products have some curious holdings, in my opinion. For example, one of the largest holdings of the IBB is Mylan. You saw Mylan in the news for the EpiPen scandal, but Mylan is a generic drug company. I think most people wouldn't say that generic drug companies are biotech companies, but they're included in products like that. Those products, it's hard to know exactly what's in them. I recommend that people look at the weightings and the individual components very closely. Another thing that I think is important is the biotech investors. As I mentioned earlier in the show, I think that this sector is changing a lot. You really have to pick and choose your areas closely because payers are pushing back on a lot of areas of this business that have incremental innovation. Diabetes, rheumatology, multiple sclerosis. These are areas where new drugs are coming out and they're not very much better than older ones. These companies have relied on price increases to keep the revenue going for them. If you're investing in those two products, you should know that you're getting exposure to what I think is low innovation and perhaps low growth. I think as an investor you want to focus on the high innovation and high growth areas, rather than getting a grab bag of everything under one umbrella.

Nate Geraci: On that note, let's talk about the Loncar Cancer Immunotherapy ETF. You developed the index behind this ETF, ticker symbol CNCR. First, before we get into the nuts and bolts of this ETF, can you explain to our listeners what cancer immunotherapy is?

Brad Loncar: I think everybody out there is familiar with chemotherapy, which in many cases is toxic and can affect the whole body. The immune system is natural. It can adapt and learn. The theory is if you can harness it to fight a disease like cancer, you might see stronger and longer lasting results. This is here today. The first generation of immunotherapies is approved by the FDA and five or six different cancers. Those are mostly being developed and commercialized by larger companies like Merck and Bristol-Myers Squibb. Then you have a whole groundswell of what we traditionally think of as biotech companies working on second and third generation immunotherapies. This has the potential to really change cancer care significantly over the long term. This is something that's going to play out over 10 or 15 years. It's already starting today.

Nate Geraci: Give us an idea here, what types of cancers can immunotherapy treat?

Brad Loncar: The most famous, the first approvals were in melanoma. You might have seen in the news a year or so ago, former President Carter took Merck's immunotherapy drug Keytruda. He had a late stage melanoma. Next was non-small cell lung cancer, so the type that you get from smoking, sadly, and then bladder cancer, kidney cancer, head, and neck cancer. For the ones that are in development now, there's a type that seems very promising in different types of blood cancers. Immunotherapy itself is not one thing. There's over a dozen different approaches to immunotherapy. They all have their own positives and negatives for different types of cancers. I would say in general, this has the potential to treat all cancers, but different immunotherapies focus on different types of cancers.

Nate Geraci: The ETF, the Loncar Cancer Immunotherapy ETF, tell us how the index behind this ETF is constructed. How are the individual stocks selected, how are they weighted, and what's the overall investment goal here?

Brad Loncar: We want to create an index that gives exposure to the 30 leaders in this space. We have a committee that gets together every six months. They make two decisions. Number one, they decide which companies within the pharma and biotech sector have a strategic focus on this area, so that the stocks are moving because of this immunotherapy. Then once they have that pool of companies that are focused on this, we essentially try to choose the 30 largest because we view that as the market's way of saying those are the 30 most credible. We also want smaller companies to have to earn their way in. We do that review process every six months. Right now we're keeping it at 30. That includes about five larger companies, like your Merck’s and Bristol’s that have the drugs today. Then 25 of those biotech’s that are working on second and third generation immunotherapies.

Nate Geraci: Again, we're very pleased to be joined in studio today by Brad Loncar. He's the man behind the Loncar Cancer Immunotherapy ETF. Brad, I'm curious, what's the back story behind this ETF? Obviously, you have a strong background in biotech as a whole, but how in the world did you end up with your name on a cancer immunotherapy ETF?

Brad Loncar: People are hearing about this concept of immunotherapy for the first time today because drugs are being approved for the first time. It's something that's been under development for decades. I've always been a believer. It's interesting, five or six years ago if you believed in immunotherapy, people thought you were crazy. It was considered literally a backwater of oncology and biotech. I've always been a believer. I wanted to create something that shines a light on it because I think it's the most innovative, interesting thing going on in biotech right now. In the spring of 2015, I put out an index that focuses on it so that people could learn more about it and follow the space more closely. Then I worked with an ETF issuer, who wanted to license it and turn it into an ETF.

Jason Lank: I find it compelling to think that we can fine tune our immune system to fight things it couldn't fight before. That makes too much sense. I want to look longer-term, as an investor. I want you to polish off your crystal ball, look out 10 years and 20 years. How will we be treating cancer? Will we have beat it? Will it be immunotherapy? Are there other things in the pipeline? Looking forward, what's out there?

Brad Loncar: As optimistic as I am, I can say sadly, we won't beat it. The reason I say that is because cancer is not one thing. You see something like a TIME Magazine where it'll say, "The cure for cancer." I always hate seeing that because there's over 200 different types of cancers. Some are more treatable than others. We're turning some of them into chronic diseases. There's a lot of reason to be optimistic, but not all cancers will be cured. Where we're heading in 10 or 15 years is personalized treatments. Before you'd hear like breast cancer, kidney cancer, and you'd think it'd be the same thing. Every person's cancer is different. Your cancer has its own genetic profile and different mutations. Companies are learning how to tailor treatments based off of that. That's the number one thing. Then the second thing that I would watch for and a term I would listen for is "genetic engineering." What we're starting to do now is taking your cells and re-programming them, editing them outside the body so that they can better fight disease when they're re-infused in the body. I think that's a big area that's really just in its infancy right now. We might see the first approvals this year. That's something that's going to be a big trend over the next 10 or 15 years.

Nate Geraci: Brad, we have just a couple of minutes left here today. To piggyback on Jason's question and maybe bringing our discussion full circle today, as you look at the current biotech landscape overall, besides cancer and all of the advances being made there, what are some other diseases where you think we may see people lives substantially change moving forward? For example, we now have a polio vaccine. That was developed back in the 1950s. We now have significantly better treatments in the rare event somebody does contract polio. Here you had a horrific disease that has been mostly contained now. Are there any other diseases out there where work is currently being done that you think we may see significant breakthroughs over the next 10 or 15 years?

Brad Loncar: This genetic engineering that I just mentioned can be used for a lot of things that are genetic-based diseases. I'm very optimistic in the future for things like sickle-cell disease, beta thalassemia, and things like that, hemophilia. There's a lot of interesting science that, for the first time, you can think of it as curative. The first step was learning what causes this disease. What is the genetic basis of it. Now, people are thinking about fixing those genetic problems. Anything like that where you have one gene that's a problem, in the future we might be able to engineer that out. I'm very excited about that. There's something else called Nash, which is a type of liver disease to keep an eye on. That's a huge problem that's growing in society right now. The cancer space is just very exciting as well, of course. There's a lot of game changing science happening right now. We just need to translate that into the clinic and make these therapies commercialized for the first time. That's starting to happen right now. It's a very exciting time to be around biotech, for sure.

Nate Geraci: Brad, with that, we'll have to leave it there. Just a tremendous conversation on biotech investing and everything occurring in the space. We greatly appreciate you joining us in studio today. Thank you.

Brad Loncar: My pleasure. Thanks for having me.

Nate Geraci: That was Brad Loncar, Head of Loncar Investments. If you want to learn more about the Loncar Cancer Immunotherapy ETF, you can do so by visiting Loncarfunds.com and Brad is also a great follow on Twitter if you just want his perspective on biotech. His Twitter handle is @bradloncar.