Dan Rasmussen & D.A. Wallach on The Future of Biotech and Healthcare | #589

Episode Summary

Executive Summary: The conversation spans biotech’s brutal drawdown, why active stock selection still matters, and how healthcare may be transformed by GLP-1s, AI, and drug innovation. DA Wallach explains his path into healthcare investing and argues for patient-centered, tech-enabled care; Dan Rasmussen frames biotech as a high-dispersion, factor-distorting universe ripe for quant research. The group also debates private equity’s overcrowding, venture capital’s true return profile, Japan’s improving corporate governance, and tax-efficient investing ideas like Roth conversions.

Main Topics: DA Wallach’s path from music to healthcare venture investing (Priority: 5/5): DA describes three careers—music, angel investing through Spotify, and now professional healthcare/biotech investing via Time BioVentures. A key turning point was his early investing success, then scaling through backing from Ron Burkle and partnering with Tim on a dedicated healthcare-biotech fund. Biotech’s drawdown and why quant models struggle with it (Priority: 5/5): Dan and DA discuss biotech’s collapse in valuation and why it breaks standard factor models. Biotech’s negative EBITDA, cash-heavy balance sheets, long-dated cash flows, and extreme dispersion make generic value screens misleading and create both risk and opportunity. Healthcare disruption: GLP-1s, AI, and ‘zero-toll medicine’ (Priority: 5/5): DA argues that drugs and AI can dramatically reduce healthcare’s inefficiency. He sees GLP-1s, cell therapies, mRNA, bispecifics, ADCs, and AI-driven diagnosis/triage as major frontiers, and proposes a patient-controlled digital healthcare wallet using crypto incentives. Private equity overcrowding and the ‘doom loop’ (Priority: 5/5): Dan argues private equity is overowned and structurally challenged: fundraising is slowing, exits are clogged, leverage is expensive, and sponsor-to-sponsor transactions dominate. He sees this as a negative spiral and a reversal from years of easy capital inflows. Venture returns, power laws, and the importance of manager selection (Priority: 4/5): The discussion distinguishes venture from buyouts: median venture funds often lose money, while top-quartile funds can outperform meaningfully. Both speakers emphasize that venture is a power-law business where picking elite managers matters more than indexing. International opportunities, especially Japan and Korea (Priority: 4/5): Dan highlights Japan’s corporate governance reforms, rising dividends, asset sales, and widespread discounts to book value—especially in small caps. He also notes Korea may be a similar opportunity, but access and implementation challenges remain. Tax alpha and portfolio design for real people (Priority: 4/5): DA pivots to taxes, arguing that after-tax portfolio construction is neglected. He shares a Roth-conversion framework suggesting meaningful long-term benefits, and emphasizes that tax efficiency can be a more reliable source of alpha than many investment strategies.

Key Arguments: Biotech should be viewed as an options-like sector: companies often lose money for many years, then either succeed massively or fail; this makes valuation and discount-rate sensitivity unusually important. Standard value metrics fail in biotech because negative EBITDA and cash-heavy balance sheets invert the logic of conventional screens; more cash and more spending can sometimes signal better prospects. The healthcare system is structurally inefficient because it relies on expensive human services for problems that drugs and AI could increasingly solve at far lower cost. AI in medicine already appears capable of doing much of what physicians do in common tasks, suggesting a future where high-quality medical knowledge is broadly accessible through software. Private equity’s performance depends heavily on buyer flows, leverage, and exit liquidity; as fundraising slows and rates rise, the sector’s structure becomes more fragile. Venture capital remains attractive only because outcomes are extremely skewed; the median fund can underperform while top-quartile managers capture the outsized winners. Public markets can replicate some private-equity factor exposures (small, cheap, levered names), so investors should evaluate the underlying factor set rather than the “private” label itself. Japan’s small-cap market offers genuine opportunity because governance reforms are forcing companies to return capital, sell non-core assets, and stop hoarding low-return assets. Tax planning, especially Roth conversions, can create substantial incremental wealth over time and deserves more attention from investors. Flows, not just fundamentals, may dominate asset-class returns; household and institutional allocations can materially move markets in both the U.S. and abroad.

Data Points: Time BioVentures fund size: $100 million - DA is now running a healthcare/biotech-focused VC fund with partner Tim. Years since Spotify investment: ~13 years ago - DA said he met Spotify’s founders about 13 years prior and made his first investment there. Biotech drawdown from peak: ~60% - Dan described biotech as being down roughly 60% from its peak. Biotech sector size in Russell 2000: ~20–30% - Dan said biotech is a very large portion of U.S. small caps. Biotech company count: 357 - Dan cited the number of biotech names in his universe of Russell 2000 holdings. Biotech lifetime profitability threshold: ~70th percentile - Dan said you need to get to about the 70th percentile of biotech stocks before lifetime profitability appears. Biotech IPO/financing environment: 3 years of shutdown-like conditions - DA characterized the public/private financing conveyor belt in biotech as effectively shut down for about three years. Patients on Medicare Advantage: More than 50% of elderly Medicare recipients - DA referenced current adoption of Medicare Advantage as part of healthcare incentives discussion. Venture fund median performance: Negative in most vintages - DA said the median venture fund has lost money across the vintages he analyzed. Venture top-quartile outperformance: ~13% average / ~8% median vs. S&P - DA’s Cambridge Associates analysis showed top venture funds outperforming public markets by these amounts. Private equity allocation at family offices: ~40% - Dan argued many high-end family offices are now around this level of private equity exposure. Charitable foundation PE exposure: Up to ~70% - Dan said some foundations may be even more heavily allocated to private equity. Private equity sponsor-to-sponsor deals: ~50% of deals - Dan said sponsor-to-sponsor transactions became a large share of PE activity as the asset class expanded. Private equity funds closed last year: ~700 - Dan used this figure to illustrate how many private equity funds were fundraising/closing. Japanese market valuation example: 0.3–0.4x book to 1.0x book - DA described a Japanese company that rerated after announcing an 8% dividend on equity. Japanese company dividend example: 8% dividend on equity - DA cited Anishikawa Rubber as a case where capital-return policy quickly re-rated the stock. Japan market cap opportunity: Sub-$400 million market cap - Dan said the most attractive inefficiencies are in small Japanese companies below this size. Cash value benchmark in biotech: $3 billion vs. $50 million - Dan contrasted the risk profile of a biotech with $3 billion of cash against one with $50 million. Roth conversion example: ~2% incremental annual benefit - DA said his analysis suggested a Roth conversion could add around 2% per year for him over 20 years.

Pivotal Quotes: "Biotech, I think, is a sector that's probably more sensitive to cost of capital than almost any other sector." — DA Wallach: DA explaining why rising rates hit biotech valuations so hard. "The conveyor belt has been shut down for three years." — DA Wallach: DA describing how biotech financing and IPO exits have jammed from private to public markets. "Nothing is making money, things have just made money." — D.A. Wallach: DA paraphrasing Ken French to critique backward-looking performance chasing and timing assumptions.

Implications: Investors should think in terms of factor exposures, cash flow timing, taxes, and manager selection—not just labels like “private” or “biotech.” The biggest opportunities may be in ignored, depressed, or reforming areas, while public-market liquidity and tax efficiency remain underused tools.