A Free Lunch

The US business press is pretty parochial, focusing on US markets and US financial industry as the primary motivators of the world economy.  So I was not surprised when I learned only recently about an innovation in funding drug discovery and development that was launched last month in the UK.  The innovation in financial engineering is a fund now trading on the London Stock Exchange called the Battle Against Cancer Investment Trust (BACIT) and it is specifically designed to generate funding for research and development of new cancer drugs.  As is my wont, I wondered about applying this scheme to the discovery of drugs for global diseases to close the funding disparity between reimbursable diseases, like cancer, and those left behind by the traditional market forces,  As toted up annually by the Policy Cures organization in their G-Finder survey, all R and D spending on products for neglected diseases totaled $3.6 billion in 2010 (G-Finder Summary) while R and D spending by the pharma industry about twenty times more or $68 billion (Reuters article).  Of that $3.6 billion, the majority (64%) is from governments, 19% from foundations, and 14% from companies, so adding a new source of money, especially one tied to a stock exchange with a $3 trillion capitalization, sounds like a good idea.

As I understand it, the BACIT’s basic format is as a fund-of-funds (FoF) that allows the average (but well-heeled) investor to buy into a range of hedge funds run by highly-paid and crafty managers who are expected to deliver an annual return of 10-15% over the life of the fund.  In addition to delivering returns to investors, the BACIT will also distribute 1% of its net asset value (NAV) annually, half to the British nonprofit, the Institute of Cancer Research (ICR), and half to the BACIT Foundation for further charitable distribution, plus invest 1% in companies through the ICR’s enterprise/spin-out group.  But unlike the typical FoF, the BACIT will have very low management expenses resulting from two generous and unusual features.  The first is that the investment team will be paid its director, Tom Henderson, not by the fund.  Henderson, a former hedge fund manager, has pledged to pay annual operating costs up to $250,000 (and also will invest $25 million of his own money).  The second is that Henderson was able to persuade 30 or so top-notch funds not to charge the BACIT management or performance fees, nearly a free lunch as said by one publication (Money Observer article).  I am guessing that the various managers agreed essentially to donate their fees to cancer research because Tom Henderson is a popular and persuasive guy, the BACIT investment will help them leverage their own funds, they make scads of money already (I hear you can’t take it with you), and everyone likes the warm glow that comes with giving money away.  More info on BACIT and its set-up is at the fund’s website (BACIT Ltd.) and in a Financial Times article (FT article) but note that US investors are not welcome.

So far, the BACIT has been well-received by at least one rating company which gave it four stars (BestInvest) and by investors who bought up $334 million in shares when the BACIT went public in late October (Reuters article).  If you have several million and would like to rebalance your portfolio ala BACIT, the fund announced its initial investments on November 20:  20% in equity hedge funds, 16% in commodity hedge funds, and the rest in equity (14%), fixed income (8%) and emerging markets (7%) funds (Investment Week article).

So what about a BANDIT (Battle Against Neglected Diseases Investment Trust)?  Although I like the name as an attention-getter, I’m not sure if its impact on neglected disease drug development would be meaningful.  Even if BANDIT was similar in size to BACIT, got a fantastic 10% annual return, and put 2% of its net asset value into research, it would add just $7 million each year to the pot or less than 0.2% of total spending, not much (but then the BACIT is adding even a smaller drop into the very well-funded cancer drug enterprise).  And worse, that dollop of funding would be spread over the 12 or so neglected diseases, meaning less bang per buck.  Another problem with BANDIT, if it followed BACIT’s scheme of seeking high returns, is high risk and the possibility of one or more low-return years, which means intermittent funding, not good for doing drug discovery which needs stable funding.

Of course, the answer to generating large and steady returns is to have a huge fund investing in a vanilla blend of stock and bonds.  Using the math skills I learned in fifth grade, I calculate the fund would need a NAV of $5 billion to generate a respectable $100 million annually for R and D.  Seems like a lot for a fund but then one of the most popular stock index funds, Vanguard’s 500 Index, has total assets of about $6 billion (Morningstar Vanguard 500) and the astute reader will remember that last month I wrote about a megafund of securitized debt for funding cancer research (also) that was proposed by MIT economics prof and hedge fund manager, Andrew Lo, that would have a value $5-15 billion (“Mega-fun”).

In my fantasy financial world, I would get BANDIT started pre-IPO with an investment from the fund behind the world’s leading global health philanthropy, the Bill and Melinda Gates Foundation Asset Trust, which has assets of about $34 billion (Gates Financials).  I think $2 billion would do it; after all, the Trust’s investments are doing well and it is getting about $1.5 billion annually from Warren Buffet and more when he dies.  Next, I’d ask Warren to head the BANDIT investment team with the main job of persuading the managers of  multiple funds of his choosing (he’s good at that) to participate in BANDIT without fees.  As for the average investor, who wouldn’t want to do good while doing well?  Finally, I’d have that annual 2% free lunch go into two programs to accelerate global health product development.  Half will go into investing in start-up or growth-stage companies through a venture capital-type firm with the expectation that one of five to ten will succeed in developing a new product.  A good model for the costs and timeframe for this program is the “Global Health Innovation Quotient Prize” published in 2011 by BIO Ventures for Global Health which is designed as a financial incentive for small companies to engage in neglected disease research and development (BVGH IQ Prize).  The other half will go into funding a business plan competition/venture accelerator program similar to the MassChallenge, but specific to entrepreneurs with ideas for products and services to improve global health (MassChallenge).  Personally, I think the Gates people would jump at the chance to start up BANDIT since the Foundation has made a few moves recently toward making investments in enterprises in addition to giving money away to academics and NGOs (see my posts, “Toe in the Water” and “Free Advice, Trevor”).  Now, where did I put Bill Gates’s phone number?


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