Scientist Stories: Andrew Lo, Securitizing Drug Development

You know, and to close up our program today, we're going to hear from a man that has big ideas and big visions for how we can do better. You know, to introduce our closing keynote, please welcome Mr. Morris Phelan, Bioprocess Leader at GE Healthcare Life Sciences, our track sponsor at this meeting, and certainly GE becoming a new player in the Massachusetts life sciences ecosystem. But Morris is no no stranger to Massachusetts. Thank you, Maurice.

Thanks, Bob. Afternoon, everybody. Before I start, I'd just like to thank Bob and the entire team, Pete and his team, for being so gracious, getting us on board. Many of you know we have a fairly big initiative going here in Massachusetts We're coming to Mass from all our locations on the East Coast in terms of healthcare life sciences, so thanks very much for that. In biopharma and biotech and drug development and manufacturing, things like understanding quantifying risk is huge for us, so I'm really very excited to get a perspective from today from Dr. Andrew Lo. He's the Charles E. and Susan T. Harris Professor at the Sloan School of Business at MIT. He's also the director of MIT's Laboratory for Financial Engineering and is a principal investigator at the Computer Science Lab at MIT and also in their Artificial Intelligence Laboratories. And I personally never knew— there was even a subject called financial engineering, so I'm really looking forward to hearing about this. He's published extensively in academic journals. He is the recipient of the Guggenheim Fellowship and the Paul A. Samuelson Award. He's been elected to many senior academia and review posts. His most recent research focuses are on systemic risk, evolutionary models for investor behavior, and applying financial engineering to accelerate biomedical innovation. So please welcome Dr. Andrew Lo from the MIT Sloan School of Management.

Well, I'd like to start by thanking Maurice Phelan for that generous introduction, and Bob Coughlin and the MassBiotech Council for inviting me here today. It's a particular honor for an economist to be asked to speak at MassBio. And I have to start with a disclaimer, which is that I am no biomedical expert. I'm not even a healthcare economist. Up until a few years ago, much of my research was on investments, and I got interested in healthcare largely for personal reasons. A family member and some friends were dealing with cancer, and so I started learning a little bit more about it. And so I want to first start by wishing MassBio a very happy 30th birthday and thanking all of you from the perspective of patients and their family members thank you all for doing what you do because you save lives every day. And I wish I could say that about economists, but I can't. And I also want to start by saying that I feel like one of the luckiest people in the world living in Massachusetts, even after this winter, because we have some of the world's most advanced healthcare centers within walking distance. We've got the world's best academic centers. We've got the world's most vibrant biotech community here. But there's one thing that is missing from that long list of world's best that we haven't mentioned at all today, and I wasn't here yesterday, but I suspect it wasn't mentioned yesterday. Within walking distance, We have one of the world's largest asset management centers. And given that there's all this concern about financing, about funding, it seems to me that we ought to bring in that element into this discussion. And that's something that I do know something about, so I'd like to talk a bit about that. Now, all of this really came to a head for me in a very personal way a few years ago when my My mother was diagnosed with non-small cell lung cancer, and I was starting to look into various different experimental therapies for dealing with it. And I was introduced to a Cambridge-based biotech company, a very successful one, and they had a number of different treatments, one of which had to do with non-small cell lung cancer. So through a friend of a friend of a friend, I was introduced to the chief scientific officer, and he graciously met with me. And he brought along his chief financial officer because he thought I might be asking some finance questions. And during the lunch, I asked what I thought was a relatively innocent question. I asked them, "Does your source of financing have any influence on your scientific agenda?" And they turned to each other and they laughed a very ironic laugh. And he turned back to me and he said, "Influence. Our financing drives our scientific agenda." And I got to tell you that from the perspective of the son of a patient, I was absolutely outraged by that answer. Because what does curing cancer with angiogenesis or immunotherapy have to do with stock market volatility? Interest rates and Fed policy? Nothing. But financing was driving their scientific agenda. And I understand why. You gotta pay for things. But that told me that the business of science has some real challenges. That we are letting the business side drive the scientific side in ways that are counterproductive, particularly to the patient perspective, and it's just not necessary. And the reason it's not necessary is that if you focus on the patient, if you are able to provide breakthrough therapies for the patient, there will be enough money for everybody concerned. And so if that's the case, then we have to think a little bit harder about that. So that's what I'm going to talk about today. I'd like to describe to you a somewhat different perspective about the business of science. One that really has to do with my area of expertise, which is finance. So let me show you a graph that I found really telling and, for me, explains a lot about what's going on in the industry. I'm going to show you the stock market performance of the pharma industry as compared to the biotech industry from 1994 to the present. So what I'm going to graph here is the NYSE ARCA Pharma Index. This is an index of the largest pharma companies. And the performance looks like that. That's pharma. And here's biotech. Now before you celebrate, I know this is the Mass Biotech Council, before you celebrate, let me show you an interesting narrative that you can't really see from this graph. I'm gonna show you the same graph plotted on a logarithmic scale. On a logarithmic scale, the slope of these lines tell you the rates of return, the growth rates of these two different industries. And you see a very interesting pattern with pharma. In the 1990s, pharma was doing just fine. And then in the early 2000s, pharma began their lost decade. Over a 10-year period, Pharma managed to destroy shareholder value year after year. Remarkable. Now biotech, during the first part of that period in the early '90s, it was up and down, very volatile, some periods of great success, particularly 1999, 2000, we had breakthrough years with triple-digit returns for biotech VC, and then some challenging times, but then Starting around 2003, biotech goes on a tear, and it's been on that track ever since. So I've drawn a line around the point at which biotech really seems to be on that steep upward trajectory. In particular, that line is drawn on April 14th, 2003. Does that date mean anything to any of you? You were probably doing your taxes on that day. That was the day that the US government announced that it had completed sequencing the human genome. Now, I realize there are many other factors involved in the growth of the biotech industry, but I just have to point to that as a really interesting breakthrough and inflection point in biotech. And of course, pharma now is coming out of their lost decade. They're not doing as well as biotech. They're not growing as fast, but we wouldn't expect them to grow as fast because they're a much bigger industry. It's a lot harder to grow when you're that much larger. But I want to argue that we are now at a point of a second breakthrough period in biotech, another inflection point. And I'm no expert in this, but I think I happen to be in a very fortunate position of being in a city where there are a lot of experts, and the experts, they tell me that these breakthroughs that happened years ago one or twice a year are happening now every week. And let me give you an example. A couple of weeks ago, a paper was published in Nature by a consortium of researchers on a map of the epigenome. This was led by one of my colleagues at MIT CSAIL, Manolis Kellis, but there are a team of many, many scientists that are producing remarkable maps of how genes get switched on and off and what that relates to in terms of human disease. Now, I can't read this paper, but I can look at the pictures. And here's a picture from that paper, a very pretty picture. And what's interesting about the pretty picture is that it lists all of these various different genes that get switched on and off, but if you look at the columns here and the rows and you look at the labels, the labels now take these various different genetic information and map them to human disease. This seems amazing to me that we are now at the point where we can start thinking about all sorts of diseases at the very molecular level. And there's a lot more work that needs to be done, certainly, and all of you are doing it. But from an outsider's perspective, I gotta tell you, this looks different than it's ever looked before. It's not the same. It's not business as usual. So the question that I wanna put to you is why is funding declining? When you are all at the point of making a number of major breakthroughs in treating all sorts of diseases, including diseases that we haven't been able to treat before, like Alzheimer's. I noticed that Rudy Tanzi was on the program yesterday. Uh, his paper on coming up with 3D models of neurons and being able to replicate these kinds of amyloid plaques in vitro, I think that's amazing. There hasn't been a single Alzheimer's drug developed in 10 years. But now things are changing. So why is funding declining? Well, we know that NIH funding is declining, and that has a really negative impact on basic science, and that's something that we have to address. But even the biotech bubble that people have been talking about, that all of you have been benefiting from, there's a sense that that is going to come to an end soon. But more importantly, if you look at venture capital, that's having an even harder time. Now, we have the luxury of being in Boston where we've had some of the most successful VCs in the world, and Mark Levin being one of them, but he's certainly not the only one. But the fact is that if you look at the VC community, in 2008 there were 201 biotech VCs operating, and as of a couple years ago, that number's gone down to 136. And part of the reason that VCs in biotech are shutting down is because money is being pulled out of the space by their limited partners. And the reason, I conjecture, I would love to get your feedback on this, the reason is because of risk. The fact is that biomedical innovation is becoming more expensive, taking longer, It's more complex, and as a result, investors behaving quite rationally are taking their money and putting it into lower-hanging fruit. I mean, as an investor, would you want to put your money in a company that's going to take 5 to 10 years to prove its value, it's going to cost upwards of $25 to $50 million, and the probability of success is 5 to 10%? Or Or would you want to put a much smaller amount in an app company, and 2 years later it gets sold to Facebook for $19 billion? It's pretty compelling. So let me just illustrate to you by way of example where the economics are. This is an example that I use with my MBA students just to get them to start thinking about this a little bit more systematically. So I want you to think about a very simple investment opportunity where I need $200 million. I need it for 10 years. And the probability that I'm going to give you any positive rate of return on this is 5%. How many of you would invest your 401(k) money or your children's 529 college plan, your parents' retirement funds, how many of you would invest in this by a show of hands? Yeah. Who wants this? It's way too risky. Now, when I give this example to my MBA students, every once in a while one of them will raise his hand and say, "Excuse me, Professor Loeb, but you didn't tell us what the rate of return is." For most people, you don't even need to know the rate of return because with a 5% success rate, no thank you, not interested. Well, this is the back of the envelope numbers for what it costs to develop a single cancer compound from Beginning to end, from preclinical all the way through FDA approval. $200 million just in out-of-pocket costs. That's not what it costs to develop a successful drug because we know that you have to have multiple trials. That's where the figure $2.6 billion for a cancer drug comes from. It's because you've got to try lots and lots of shots on goal before you hit one. But it turns out that if you do hit one, a typical cancer drug produces about $2 billion a year in revenues or in earnings, and by the time you get it approved, you've got 10 years left in your patent life, which means from years 11 to 20, you're getting $2 billion a year, which capitalizes to a $12.3 billion payday in year 10 from a $200 million investment in year 0 with 5% probability. With 95% probability, You get a minus 100% return. You lose everything. Okay? And so for those of you who are quantitative investment fans, that corresponds to a rate of return of about 12% on average with a standard deviation of 423.5%. So now how many of you would like to invest? Yeah, nobody. Do you understand why funding is leaving the space? It's because this is too risky for anybody to take on. So what if instead of investing in one of these, what if you invested in 150 of them all at the same time? Now, you might say that that's insane because you need $30 billion. The entire size of the biotech industry last year at the top the total amount of money invested in biotech was $6.9 billion. Where do you get $30 billion? Well, as an economist, I have a very simple answer. Assume you have $30 billion. I'll come back to how you get it later. But suppose we had $30 billion. Suppose we had this crazy amount of money. And assume that you have 150 cancer projects that are all statistically independent, each with a 5% probability of success. What's the likelihood that you'll have at least one success? Well, that's 1 minus the probability that you'll have no successes. And the probability that you'll have no successes is 0.95 raised to the 150th power. Turns out that the probability of at least one success is 99.95%. You're almost assured a guaranteed success if you have 150 of these. It's gonna cost you $30 billion, but the numbers actually become very attractive because diversification changes the risk of the business. Multiple shots on goal will reduce the likelihood of failure. But can we really raise $30 billion? And the answer is, it depends. It depends on the underlying risk and return of the portfolio. But let me show you with this back-of-the-envelope calculation what you can do. Given the low risk of failure with 150 independent shots on goal, you can actually raise money from debt markets. These are markets that traditionally the biopharma space has not tapped. So let me give you an example. What's the probability of at least 2 hits out of 150? Well, you can work that out. It's a binomial distribution. Turns out that it's 99.59%. It's a little bit less than 99.94% for that one shot, but for at least 2 successes, you can get 99.59% probability, which means that you can, you'll have at least 2 times $12.3 billion in year 10. If you have 2 times $12.3 billion in year 10, you can issue 10-year bonds with a face value of at least 2 times $12.3 billion without defaulting. And what's the probability of default? It's 1 minus 99.59%, which puts you in double and triple-A territory. As of last month, the AA yield was 2.43%, which means that if you issue those 10-year bonds, you've got $19.3 billion today. Almost two-thirds of that $30 billion you can finance by issuing cancer bonds, and the probability of default is very low. And if you allow me to use all the tricks of the financial trade, Things like credit default swaps, collateralized debt obligations, all the things that gave us the financial crisis. Yes, I can do even better. Now you might say, well, is that really a good idea? Well, I have to admit that actually it was the financial crisis that got me to think along these lines. The financial crisis was created not because these tools didn't work, work. It was created because these tools worked way too well. They are incredibly good at taking large, massive amounts of funding and channeling them like a laser to particular areas. So why not use these same tools for funding biomedical innovation? With the right structures, we can do that. Now, you might be skeptical about this, and I was too when I first started looking at this. But I want to put to you today that Massachusetts can cure cancer. And let me describe to you the vision and see if you agree. I want you to imagine that we created a cancer mega fund, a fund that had, say, $30 billion in it dedicated to eradicating cancer. And I want you to imagine that we had the very best possible organizations involved in contributing projects, early-stage projects, preclinical projects, projects that currently now are not getting funding because they're too early, they're too risky even for venture capitalists to take on. And so let's imagine a portfolio of projects from, I don't know, just a few of the organizations that are within walking distance here. Of where we are sitting today. So we've got a portfolio of 150 projects from these organizations. You may have heard of a few of them. And let's suppose that we get the very best advisors to manage the fund. On the scientific side, let's suppose we had Ed Benz, Bruce Chabner, George Dimitri, Jeff Flier, Bob Langer, Eric Lander, Phil Riley, Phil Sharp, Henri Termiere. And on the financial side, the business side, we had Phil Gross, Abby Johnson, Seth Klarman, Mark Levin, Terry McGuire, Bob Merton, Phil Regan, Ray Stata. Imagine that all of these individuals participated in managing this fund. Now you might say, how are you going to get these folks to participate? It's a challenge. The folks in blue, they have no idea who I am.. And so if I call them, I doubt they'll return my phone calls. And the folks in green, most of them do know who I am, which is why I know they won't return my phone calls if I call them. But if you raise $30 billion, I promise you every single one of these folks will return your phone calls. Not because of the money. The folks in blue, they're not motivated by money. They couldn't care less about the money. And the folks in green, They have all the money. But with $30 billion, you can actually make a difference. That's why they'll be involved. That's why they'll return your phone calls. And now, imagine if this fund were offered by a very large and reputable mutual fund family. I don't know, anybody know of any large mutual fund complexes based in Massachusetts? And so now I'm going to ask you the second investment question of the day. If we were to create such a fund, how many of you would be willing to invest $3,000, one-time investment of your 401(k), your children's 529 college plan, or your parents' retirement fund? How many of you would be willing to invest on a one-time basis? Before you answer, though, before you answer, I want to close with a story that got me to think about this in a very different way. I want to tell you about a colleague of mine at MIT by the name of Harvey Lodish. Lodish is a faculty member in the biology department and a member of the Whitehead Institute. And I got to tell you that I want to be Harvey Lodish. And I'll tell you why I want to be Harvey Lodish. In 1986, Harvey was an assistant professor in biology at MIT specializing in cell biology, and he was approached by an entrepreneur, a venture capitalist, who asked him to help out on a project to develop a cure for a rare disease called Gaucher syndrome. And so Harvey agreed to do so, did some consulting for them, got some shares, in a startup if they were ever going to do one. And in 1992, just 6 years later, they got a drug approved, Seradase, which is an enzyme replacement therapy for those who have Gaucher. Now, this company called Genzyme went on to bigger and better things. Harvey did well. But that's not the end of the story. That's not why I want to be Harvey Lodish. In 1992, Harvey's daughter became pregnant with his first grandchild. And this baby was diagnosed in the womb with Gaucher syndrome. Now, for those of you who know about Gaucher, you know that it doesn't necessarily express itself. It's a disease that will either become much more serious or not when you reach puberty. In 2012, Harvey's grandson Andrew did develop Gaucher. He's doing just fine because he's taking grandpa's drug. That's a pretty amazing story. When Harvey developed the drug with Genzyme, his daughter wasn't even married. And yet he saved his grandson's life. That's why I want to be Harvey Lodish. I'd like to be able to do that, but I can't. I'm not a molecular biologist. But I can if I invest in a fund that will develop a cure for my grandchildren. So now let me ask you, how many of you would be willing to invest $3,000 of your 401(k)? I only needed 8% of you to say yes. Because 130 million households, 8% says yes, I got my $30 billion. The money is here. We have the money. We don't have the vehicle to be able to channel the money in profitable ways. You can do well by doing good. They're not mutually exclusive. And with your help, with the help of this community, with the help of the Massachusetts government, with the help of all of the resources that we have sitting in this room today and within a 5-mile radius, we can cure cancer. Thank you. Happy to take questions, comments.

Yes.

So based on your slide, it looks like you've pretty well thought out who all the people are and the necessary parties to make this happen. So the question is, are you doing it? Well, so first of all, I appreciate that vote of confidence, but I have no credibility or expertise in any of this. What I've been trying to do is to bring together all of the parties who do have the expertise and the credibility. So at MIT, we've had a couple of conferences now called Cancer X. You can take a look at it online, see the participants. We tried to bring together the various different stakeholders, and we're in the process of creating some smaller working groups to try to figure out how to do this. And we have been in touch, you know, with large organizations like Fidelity and others, as well as the academic organizations that I listed, to see whether or not there's a way that we can work together. But as all of you know better than I do, there are many challenges that need to be resolved, things like, IP rights, you know, various kinds of regulatory hurdles, how do you manage projects that are so complex, and so on. So I have no expertise in any of that, but fortunately, I know a number of people who do. And so we're working on it, but, you know, we'd love to get, you know, more help and more, you know, more visibility. And at some point, we'd love to get the Massachusetts state government involved in this, because I think they can play a critical role in the way that the state of Connecticut, the state of Texas, the state of California has really been able to accelerate biomedical innovation.

Yes. Well, first of all, thank you for a great presentation. I read about your concept from a couple of years ago when it was first published in The Economist, and I've always wondered since from my understanding of how you put this together, there's a certain assumption about the cost of drugs. How, as we lower the risk, which is built into the current cost of drugs, how does that factor into the ultimate return?

Yeah, so that's a great point, and it's something that I'm actually working on as well in a couple of different ways. First, let me express the fear, and then let me try to deal with the fear. The fear is that we create all these wonderful drugs and, you know, we price them and ultimately the government won't let us charge what the market will bear. And as a result, the investors are going to get burned because they're not going to be able to earn the kind of revenues that we're projecting. So I actually asked a number of healthcare experts whether or not we're anywhere close to getting to the point where the healthcare system will not allow Pharma to charge the kind of fees that are necessary. And I was told by these experts that while there is lots of sensitivity, and Sovaldi, you know, is maybe the warning shot that starts this discussion, that we are so far away from imposing price limits on drugs that are really genuinely effective. Really efficacious drugs will be paid for, and people recognize that, you know, that's not going to be an issue. The case in point that I look at is Alexion Pharmaceuticals, the rare disease that they deal with, paroxysmal nocturnal hemoglobinuria. Soliris is an incredible drug that deals with that disease. They charge $440,000 a year. For that drug. And they've gotten a little bit of pushback, but relatively little given, you know, what they're charging. On the other hand, Sovaldi is a very different issue. That's an issue that has to do not so much with the price of the drug, but with the ability for payers to pay because it's priced all up front. So one way to deal with that, what I'm working on right now, is a way to finance it. So $84,000 seems like in my view, a very inexpensive treatment that cures hepatitis C. I think it's amazing, especially given what it costs to care for patients with hepatitis C, what a liver transplant costs, and so on. But the issue is you're charging it all up front. What if instead you created a financing plan that said that instead of paying $84,000, you pay, you know, a much lower fee per year for as long as you live. And therefore, if you don't live that long, you don't pay as much, so you're actually paying for performance. And there is actually some connection between quality of life and length of life and what you pay for it. That's something that would be a lot more palatable to payers because you're not talking about an $84,000 hit right away. You're talking about a much smaller amount over a longer period of time. The financing ends up being a lot more convenient.

Yes. I think this is fabulous. As a one-time economist, I wanted to make a friendly amendment and see what you think about this, that it be a family of funds so there are economies of scale scale synergism and competition. Yes. And so it'll be mass cures cancer, then it'll be mass cures neurological diseases.

Absolutely.

Mass cures autoimmune diseases and mass cures inflammation.

Right. I, I couldn't agree with you more. The reason that I picked cancer, obviously for personal interests, uh, because of the friends and family that have been affected, but the other reason is because cancer has a very well-developed network both in terms of the science, the business, and the patient advocacy. Everybody knows what cancer is. Everybody's been touched by cancer in one way or the other. So in terms of the marketing effort and raising the funds, there's going to be no issue about that. Once you build one fund, my sense is that 1,000 flowers will bloom. And so I agree with you heartily that if you have a family of funds, you're going to have a number of patient advocacy groups that can get behind each one of them and can really catalyze the public to be able to participate. Somebody actually talked to me about that and said, "Don't you think that's kind of dangerous? I mean, won't that create a bubble just like we had with the financial crisis?" And my response is, "Well, you know, if we end up creating a bubble in cancer research and we have too much money going into curing cancer, I can sleep at night. I'm okay with that." Thank you.