Biotech Hedge Funds: A Match Made in Heaven

If you had to pick a single industry that could be interesting to every hedge fund investing in individual companies, it might be biotech.

Of course, “biotech” is not an official hedge fund strategy.

It’s more of an industry focus at the intersection of several other strategies, such as long/short equity, event-driven investing, and even merger arbitrage.

While plenty of bankers and equity research professionals from healthcare teams enter biotech hedge funds, people with advanced degrees (M.D., Ph.D., etc.) also find their way into the industry.

So, many career changers seeking exits from medicine or academia get interested in the field.

It can potentially be a great opportunity, but only if you understand the fundamentals, including the risks and caveats:

Why Do Hedge Funds Like Biotech So Much? And What Do They Do?

Biotech Hedge Funds Definition: Biotech hedge funds bet for or against public biopharmaceutical companies, typically based on catalysts such as clinical trial results, acquisitions, and liquidations; many funds focus on early-stage companies, but some also invest in “platform companies,” and some also make private-market investments.

Hedge funds tend to love biotech because:

1. There’s an opportunity for huge gains in short periods (and huge losses as well!).
2. Many biotech stocks are relatively uncorrelated with the broader market because they trade based on catalysts rather than GDP growth, inflation, interest rates, or consumer spending.
3. Biotech stocks let hedge funds bet on very specific aspects of company performance. It’s not just “Will the drug succeed?”; they can also bet on the timing, the market size, the pricing, and even the margin profile.

In technology, as a startup keeps raising capital, it normally does so at gradually higher valuations as its customers, users, and revenue grow.

But in biotech, companies’ valuations often remain close to their total capital raised until much later in the process (i.e., their Enterprise Values are not worth much for a long time):

Hedge funds focusing on public biotech companies step into this process after the “IPO” part, which means they can bet on extreme value inflections based on binary outcomes.

In other words, if the drug passes its clinical trials and wins regulatory approval, maybe it eventually sells billions of dollars, and the company’s stock price soars by 200% or 500%.

But if it fails, the company is worth almost nothing, and its stock price could fall by 90%.

Most hedge funds go beyond this, though, and bet on market size, pricing, and other factors.

For example, a company may have won approval for its drug and indicated that its expected “peak sales” will be $5 billion annually.

Based on this, the market values the company at a 1x Enterprise Value / Peak Sales multiple, so its current Enterprise Value is $5 billion.

However, a hedge fund has dug into this market, the company’s sales force, and possible additional indications for the company’s drug and believes that its peak sales will be closer to $10 billion.

If the fund is right, the company is potentially mispriced by 50%, and the share price has the potential to double once the true sales potential becomes clear.

Example Biotech Trades

The simplest biotech trades are described above: Betting on or against a company based on its clinical trial outcomes, pricing, or market potential.

For example, one company covered in our Biotech Valuation course is Ventyx Biosciences, which went public and planned to issue a follow-on offering to fund its Phase III clinical trials for treatments related to psoriasis and inflammatory bowel disease.

After running the numbers and estimating the sales potential and cash flows in different scenarios, we concluded that the company was significantly overvalued at its share price of $34.73 at the time of the planned offering:

Based on this valuation difference, this was an easy “Short” or “Do not invest.”

A few weeks later, the company announced apparently positive Phase II trial results from its VTX-958 drug… but the stock immediately fell by 73%.

Eventually, it dropped by over 95%:

Although the drug “worked,” it did not work well enough to justify as a commercial product, so the company paused all development.

At a biotech hedge fund, you dig into companies and clinical trials like this one to assess the efficacy and market potential of drugs and long or short stocks based on your findings.

Of course, many other trades are possible.

For example, a hedge fund could long or short a much larger “platform company” (multiple commercial drugs and products under development) based on an upcoming product launch or acquisition.

It’s also possible to bet on legal battles.

One example I’ve been following is a feud between Liquidia [LQDA] and United Therapeutics [UTHR].

Liquidia is a pre-revenue biotech company with a treatment for “certain pulmonary hypertension indications” (shortness of breath, low oxygen levels, high blood pressure, etc.).

United has a similar commercial drug (Tyvaso) and has been trying to block Liquidia from entering the market for years, including via a patent infringement lawsuit.

Currently, Liquidia has won “tentative approval” for its drug (Yutrepia), but the final approval status is unclear, and its stock price has fluctuated with all these developments:

If you were at a hedge fund, you could play this situation in many ways:

• Long LQDA, Short UTHR: This might work if you think Liquidia will win and take away market share from United.
• Short LQDA, Long UTHR: This works if you have the opposite view.
• Long LQD, Long UTHR: Maybe you don’t know which company will succeed, but you want to take a bullish view on the overall sales potential for both pulmonary hypertension drugs.

You could come up with dozens of other potential trades if you also consider call and put options, biotech indices/ETFs, and merger arbitrage ideas.

What Makes Biotech Hedge Funds Different?

I consider biotech hedge funds a sub-category within long/short equity hedge funds, which means many L/S equity qualities also apply here.

For example, most biotech hedge funds have a long bias (more capital devoted to long positions than short positions), use moderate leverage, and are relatively liquid.

However, there are a few differences:

1) Relative Market Neutrality – Many biotech stocks, especially pre-revenue ones, are relatively uncorrelated with the broader market. They trade based on catalysts like clinical trial results, drug launches, and early sales indications, so they’re much less sensitive to macro factors than consumer/retail or industrial stocks.

2) Portfolio Concentration – The average biotech hedge fund has a concentrated portfolio because it takes significant time and resources to monitor each position. For example, there are multi-billion-dollar biotech hedge funds with 10%, 20%, or even 30% of their total capital in single companies:

3) Public / Private Crossover – Finally, many biotech hedge funds also have divisions that invest in private startups, similar to life sciences venture capital firms and healthcare growth equity firms.

One example of a firm in the last category is Deerfield Management, one of the world’s largest healthcare investment firms.

It operates venture capital, private equity, and private credit funds and even does strategic partnerships with universities and institutes.

The Top Biotech Hedge Funds

All the large multi-manager hedge funds and multi-strategy funds have a presence in biotech, but their focus and performances vary widely.

Larger, diversified funds known for their biotech teams and strategies include Farallon, Glenview, Marshall Wace, Point72, and Woodline.

Then there are dedicated healthcare/biotech funds, with the three biggest being Baker Brothers, Deerfield, and OrbiMed, each with over $15 billion in AUM.

Other large funds include Perceptive Advisors, RA Capital, and RTW.

Then there are mid-sized funds with between $1 and $10 billion in AUM, such as Braidwell, BVF Partners, Casdin Capital, Cormorant Asset Management, Deep Track Capital, EcoR1, PFM Health Sciences, Polaris Partners, Rock Springs, and Vivo Capital.

There are dozens of other funds in this size range, but this is enough to get you started.

Finally, there are also newer/startup biotech hedge funds, often spun off from existing multi-managers.

Two examples include Vestal Point (led by a former Point72 Portfolio Manager) and Cutter Capital (former Citadel investors).

Some mutual funds and ETF providers also have separate biotech hedge funds; one example is Janus Henderson’s Biotechnology Innovation Fund.

There do not appear to be many European biotech hedge funds. I found one example – Rhenman & Partners in Sweden – but did not see much else.

Recruiting for Biotech Hedge Funds

The main pathways into biotech hedge funds are healthcare investment banking, healthcare equity research, biotech equity research, and other hedge funds that operate in adjacent spaces or strategies.

But due to the sector’s unique characteristics, you don’t necessarily “need” one of these specific backgrounds to get in.

For example, if you work in life sciences venture capital or growth equity, you could potentially recruit for “crossover” biotech hedge funds that also invest in the private markets.

Healthcare private equity is less relevant since most PE deals do not involve biopharma companies, but you might still have a chance if you can find a larger fund with a diversified industry/company focus.

If you have an advanced medical or academic background (e.g., an M.D. or Ph.D.), you can also leverage your science skills to get in.

However, in most cases, the advanced degree alone is not quite enough because you’ll have to demonstrate some knowledge of finance, valuation, and the commercial side of biotech.

For example, a top MBA or a stint in corporate or business development at a healthcare company would help your case significantly.

If you have a purely academic or medical background and cannot gain finance experience, your best bet is to target smaller hedge funds that spend a lot of time on fundamental research.

The more a fund investigates a company’s science and clinical trial data, the more useful your background will be.

As with most other hedge funds, recruiting is mostly off-cycle, which means you’ll need to put in the effort to find firms, look up professionals on LinkedIn, and do proactive outreach to network with them.

Interviews, Case Studies, and Investment Pitches

Interviewers will ask the usual questions about your story, strengths and weaknesses, why you want to work at this specific hedge fund, and so on.

Technical questions will focus on accounting, valuation, and biotech-specific industry differences, such as how to estimate a drug’s potential market size or research & development costs.

As always, we recommend preparing at least 1 “Long” pitch and 1 “Short” pitch.

The most efficient way to do this is to find a few public biotech companies that have already passed Phase II clinical trials and have a lot of data and financial information.

Then, create simple forecasts based on the potential patient count and pricing and find one that seems to be undervalued and another that is overvalued or has a low chance of succeeding for scientific/market-based reasons.

Your investment thesis should focus on these questions:

1. Will the drug “work”? What is the success probability based on past data for similar treatments?
2. Will the drug be approved by regulators? If so, for which diseases or conditions?
3. What are the likely pricing and addressable patient counts based on similar, existing drugs?
4. How long will it take for the drug to launch and reach “peak sales?”
5. When will generics enter the market and reduce sales and cash flows by 90%+?

Stick to straightforward companies with 1 – 2 main products and aim for simple DCF models that take no more than ~100 rows in Excel.

The Module 1 case study for Antios in our Biotech Valuation course has a good example of such a model.

Careers and Exit Opportunities

“Careers” have much more to do with single-manager vs. multi-manager status, the fund size, and your PM rather than the industry focus.

The main biotech-specific issue is the need to establish upfront the exact type of investment process your fund uses.

For example, many smaller/newer biotech hedge funds like to hire people with M.D. or Ph.D. backgrounds to do “deep research,” but this scheme may also limit your advancement opportunities.

Even if your judgments are sound, it might be difficult to move up because you won’t get much exposure to skills like position sizing, risk management, or timing. Depending on how the fund is structured, you might not even get much exposure to basic financial analysis.

So, if your main goal is advancement into an eventual PM role, you should target funds with less “siloed” roles where everyone does a bit of everything.

With exit opportunities, the field is wide open because the biotech valuation/analytical process applies to many different finance roles.

You could potentially move back into investment banking, join a “platform” biopharma company that is highly acquisitive, or even join a life sciences venture capital or growth equity firm.

You would not be the best candidate for something like a healthcare private equity firm that acquires hospitals or nursing homes, but you’d fit in well with many other healthcare investing/advisory firms.

Recommended Resources

If you want to learn the sector, start by reviewing the investor presentations and filings of public, pre-revenue biotech companies and getting practice with basic forecasts and probability adjustments.

Beyond that, we recommend these sites:

• BioPharmCatalyst – For quickly generating stock pitch ideas.
• BioCentury – Great coverage, but all paywalled.
• Biopharma Dive – Similar, but more free content.
• Matt Gambler’s Biotech Newsletter – One of the more consistent Substacks.
• Clark Street Value – Many “broken biotech” investment ideas based on liquidation and sale scenarios.

Final Thoughts on Biotech Hedge Funds

To an outsider, biotech investing seems quite fun: Play your cards right, and you could get a quick 200% return if the company you bet on delivers a blockbuster drug.

Also, biotech hedge funds are open to a wider variety of candidates… as long as you know something about the industry.

All that seems positive, but there is one big downside: It is very difficult to make money consistently because of the high risks.

There’s a reason why firms like Baker Brothers are outliers – many other biotech hedge funds make a few good bets and have solid initial performance but then underperform and eventually shut down.

You could easily make the case that biotech is the most “volatile” of all long/short equity strategies.

If you don’t mind this and are OK with potentially many team/firm switches, it might be the right sector for you.

But if not… maybe think about long-only funds, mutual funds, or a more “boring” strategy, like merger arbitrage.