How Innovative Finance Can Drive Innovative Science: The Case for Research Backed Obligations and "Megafunds”
How Innovative Finance Can Drive Innovative Science: The Case for Research Backed Obligations and "Megafunds”
Roger M. Stein, PhD and Sean Khozin, MD, MPH
What if we could fund drug development by attracting a much wider range of investors with a much deeper pool of capital to deploy? What if the funding was already available and we just needed to use financial theory and portfolio management tools to transform investments in drug development look more like “regular” investments for pension funds, university endowments, and sovereign-wealth funds?
This is already happening.
In 2012, MIT researcher Roger M. Stein (coauthor of this post) along with his collaborators Andrew Lo and Jose-Maria Fernandez set out to answer just these questions. Fernandez, Stein and Lo took a novel approach, by repurposing some of the powerful financial tools that are usually reserved for complex derivatives, to create a potentially game-changing approach to financing cancer drug development. The team called these investments Research Backed Obligations (RBOs). Stein, Fernandez, and Lo showed that RBOs, and their simpler cousins “megafunds,” could be used to radically reduce the risk of investing in cancer therapies. The methodology was conceptually simple, adapting traditional portfolio theory approaches to support the construction of a large megafund that invested in multiple early-stage drug assets in parallel. Nonetheless, properly constructing a portfolio of multiple early-stage drug assets using this new approach would result in an investment profile with much lower probability of losses than the traditional “one-shot” investment strategies, while delivering highly attractive returns.
By extending the megafund structure to accommodate debt financing, the collaborators went on to show (using mathematical techniques typically applied to financial assets) that the portfolio itself could enable less-expensive debt issuance, reducing the amount of equity required, freeing up more of the investment capital for drug development, and further improving investment returns. Such instruments would be attractive to a wider range of investors, such as pension funds, university endowments, and sovereign-wealth funds, who typically invest in lower-return assets than venture capital firms.
The cancer megafund idea was the result of years of research, motivated by the notion that financial engineering solutions could play a significant role in drug development by enabling better and more efficient financing. By using financial tools such as securitization and efficient portfolio construction, the researchers showed that pooling candidate drugs into a megafund could lower the risks and costs of drug development, making the sector more attractive to a wider range of traditionally-minded investors.
The proposal for a cancer megafund represents an innovative approach to funding drug development, which despite being still in its early days, has already yielded impressive results. Various forms of the megafund structure have been employed to direct billions of dollars from capital market investors who typically do not participate in "venture" funding, providing critical resources for the development of new therapies. As a result of this capital infusion, a number of drugs have been brought to market, offering hope and relief to patients suffering from rare diseases. Without this funding, many of these therapies might have remained stranded, leaving patients without safe and effective treatment options. The megafund has proven to be an invaluable tool in advancing the fight against cancer and other devastating illnesses, and its continued success promises to bring even greater benefits in the years ahead.
RBOs offer a promising and complementary financing model that goes beyond traditional venture capital. By smoothing out the risks associated with technical failure and reducing the costs of drug development, these structures can provide a much-needed boost to translational cancer research. The early success of RBOs and similar models demonstrates the potential for multidisciplinary approaches to address healthcare and drug development challenges, especially in today's uncertain macroeconomic conditions. The RBO and megafund structures which have already unlocked funding for critical biomedical research are proof that advancing research in finance can drive innovation in science and drug development. RBOs, in particular, serve as a compelling example of the importance of integrating financial expertise into biomedical research efforts to achieve better outcomes for patients and society as a whole.
Dr. Stein’s TED talk below provides more details on the megafund approach: