“A psychological placebo”: Why this hedge fund manager is betting against drug companies in the race for a Covid vaccine

Vaccine

The frantic hunt for an effective vaccine against coronavirus could leave some pharmaceutical companies highly exposed in a fiercely competitive race – and UK hedge fund Argonaut Capital is weighing in with several key bets against the sector.

Argonaut’s CEO and CIO Barry Norris, who runs the firm’s Argonaut Absolute Return equity long/short fund, is avoiding large blue-chip drug names such as AstraZeneca and Pfizer (“the vaccine doesn’t really move the dial for them,” he says) as well as small-cap stocks, where there is a liquidity risk. 

Instead, he has built short positions against the “five biggest pure plays” in the sector, including Moderna – which has a USD25 billion market cap – along with US-focused German companies BioNtec and CureVac, as well as Novavax. 

“None of them have ever brought a drug or a vaccine to market successfully,” Norris says of his targets, which he sees as being overvalued. “Between them they’ve got about USD500 million of revenues this year, but they’ve got a USD50 billion market cap. There’s a lot of hope and speculation in those share prices.”

‘Deluded’

Outlining his investment thesis, he notes there are more than 321 SARS-CoV-2 vaccines currently in development – six of which are now in phase 3 trials – in what has become a “very competitive landscape.”

“This idea of a vaccine as being the only solution – even though that’s not in my mind correct – has obviously helped pump up these stocks,” Norris tells Hedgeweek.

“What the drug trials have demonstrated so far is that if you inject people at least twice with a Covid vaccine then they can demonstrate an antibody response with tolerable side effects in healthy adults. But that’s pretty easy to do, so therefore you’re not going to earn supernormal profits if there are over 300 companies that can do that.” 

Delving deeper into some of the challenges facing drug firms, he notes there is still no vaccine for the common cold, and while flu vaccines can mitigate flu symptoms, seasonal strains still kill between 290,000 and 650,000 every year, according to the World Health Organisation. Meanwhile, polio and smallpox vaccines took decades to develop, and there is still no HIV vaccine after more than 40 years, he notes. 

“A lot of investors have been drawn to these companies like a moth to a flame because obviously it's a good story: somebody potentially has the solution to Covid. 

“But those investors are extremely naïve if not deluded if they think that any one single company is going to have a vaccine approved and earn supernormal profits,” says Norris, whose Argonaut Absolute Return strategy is up more than 28 per cent year-to-date after gaining 3.42 per cent in August.

“As a group, if one of them gets lucky, then the other lot will go down, so you hedge yourself by being short all of them,” he explains of his positioning. 

Challenges

Looking ahead, he expects a high degree of volatility in pharmaceuticals’ share prices as the hunt for a vaccine remains in the spotlight. And while many pharmaceutical manufacturers have seen their stock price surge since the coronavirus outbreak, with investors banking on a vaccine, the path to an effective treatment remains fraught with hurdles.

AstraZeneca, the UK drug firm exploring a potential vaccine along with Oxford University research teams, has only just resumed its tests in the UK, Brazil and South after phase 3 of its global trials were paused earlier this month when a participant fell ill. Oxford University researchers involved in the project believe the illness may not be linked to the trial. 

At the same time, uncertainty remains over the long-term effectiveness of any potential treatment, particularly among the older population, as well as manufacturing capacity, according to Susanna Urdmark, portfolio manager of the Rhenman Healthcare Equity Long/Short strategy.

In a Rhenman webinar last month, Urdmark – whose fund trades small, medium and large pharmaceuticals, biotechnology, medical technology and service company stocks – believes there could be “a number of vaccines approved by year-end” amid “intense activity”. But she cautioned that this remains a best-case scenario.

London-headquartered publicly-traded hedge fund giant Man Group recently warned that any victory in the vaccine race may ultimately prove to be “more reputational than financial” for drug firms, who still often score lowly on ESG (environment, social and governance) metrics thanks to perceived price-gouging and aggressive marketing practices.

In a wide-ranging commentary, Man GLG analyst James Terrar and Steven Desmyter, co-head of responsible investment at Man Group, pointed to “a wave of retail money following institutional interest” in pharmaceutical and biotech firms involved in drug trials, sparking a “substantially rally” in the four major biotech firms’ share prices.

But they added: “If investors are banking on a windfall from a Covid-19 vaccine alone, these investments may prove to be almost as short-sighted as the mass retail buying of airline and energy stocks in May.”

Confidence boost

Ultimately, Norris believes a vaccine may be the “wrong solution” to Covid-19. The difference in mortality rates and hospitalisation numbers among various sectors goes to the heart of his bearish stance on vaccine developers.

While a vaccine may provide added immunity in healthy adults, Norris maintains this sector of the population faces little risk from severe symptoms or hospitalisation. On the flipside, initial drug trials have shown little sign of “statistically significant” antibody responses in elderly populations, and none in people with degraded immune systems – the two groups most at risk of serious illness or death from Covid-19. 

“None of the vaccine developers are even suggesting that the vaccine will actually stop or prevent all infection,” he adds. “You may have a situation where younger and healthier people take the vaccine and think they’re not at risk from Covid anymore; they then stop social distancing, but actually end up spreading it to those who might die from Covid.”

Instead, he points to certain cheap generic drug and steroid-based treatments that have offered effective results, either by reducing mortality rates or shortening the length of stays in hospitals, as well as hydroxychloroquine, which he acknowledged has become “incredibly political” after Donald Trump spoke in favour of its use.

Touching on coronavirus’s political dimension, he contends that governments are now pinning their hopes on an approved vaccine to help return economies and society to normal, and “dig them out of their own very deep policy hole.”

By “completely misunderstanding” the virus as a “second Spanish flu” - rather than as a disease that infected a very select part of the population with impaired immune systems – he believes policymakers enforced strict lockdowns as a “panic measure” that has sent economies spiralling south.

“Even if you have an efficacious vaccine in healthy adults, which we could get for Covid, it may have no public health benefit because the only people you’re helping are people that are not at serious risks from Covid anyway.”

A Covid vaccine then becomes “almost like a psychological placebo” which gives people something of a confidence boost as economies begin to unlock, he says.

“But, of course, that is not a product or a vaccine which anybody is going to generate supernormal profits from.”