Investing in Biotech with Verdad Capital

Episode Summary

Executive Summary: Andrew Walker interviews Verdad Capital’s Dan Rasmussen and Greg Obenchain about their biotech investing paper. They argue biotech is unusually suitable for quant/value methods if you use sector-specific signals: specialist-fund ownership, insider buying, spending, momentum, and short interest. The core insight is to ignore traditional profit-based metrics and instead analyze who owns what, who is buying, and how much capital has been deployed.

Main Topics: Why biotech is a quant/value opportunity (Priority: 5/5): Biotech is a large share of small-cap markets, highly idiosyncratic, poorly covered by traditional value screens, and often excluded from quant models despite offering distinct return patterns. Specialist ownership as a signal (Priority: 5/5): The strongest finding is that stocks owned by multiple biotech specialist funds tend to outperform, while names with zero specialist ownership perform poorly. Consensus among specialists matters more than any single star manager. Shorting biotech with risk controls (Priority: 5/5): Biotech is fertile for shorting because many firms lose money and fail, but shorting must be diversified and systematic due to explosive upside risk and promotional catalysts. Insider buying and capital commitment (Priority: 4/5): Non-CEO insider buys, especially by CFOs and broader management teams, are meaningful bullish signals in biotech because insiders know the science and company trajectory before the market does. Reframing value around spending (Priority: 5/5): Because many biotech firms have no meaningful profits or revenue, Verdad substitutes a spend-based value framework, treating cumulative cash deployment as a proxy for embedded R&D value and sunk scientific effort. Momentum and peer/trial similarity (Priority: 4/5): Biotech momentum works not just at the stock level but across similar companies and themes; clinical, therapeutic, and peer-group exposures move together as markets reprice broad narratives. Data challenges and ongoing research (Priority: 3/5): The guests emphasize that biotech is messy—warrants, PIPEs, phase changes, strategic ownership, and classification issues all complicate modeling, so the paper is a first pass in an evolving research pipeline.

Key Arguments: Traditional value screens fail in biotech because many names are money-losing science projects, so investors need biotech-native signals instead of profit-based metrics. Specialist-fund ownership is a powerful consensus indicator: companies owned by many biotech specialists outperform, while stocks with no specialist ownership perform badly. Consensus among specialists is more predictive than backing from a single top specialist; the crowd’s agreement is the signal. Biotech shorting should be diversified and systematic, not concentrated and conviction-driven, because single-name shorts can be devastated by trial results or acquisition bids. Short interest and borrow cost help identify crowded, low-quality, or questionable names, and the signal is useful across sectors. Insider buying matters more than insider selling in biotech; buys from CFOs and management teams are especially informative, while CEO buys are less discriminating. Spend is a better value anchor than profit in biotech because cumulative cash burn reflects the amount of scientific work and external capital committed to the company. Momentum in biotech often reflects broader thematic or peer effects rather than just company-specific events; markets trade narratives such as obesity, oncology, or mRNA as groups. The portfolio should be diversified and rebalanced frequently so the model benefits from these signals without relying on single binary outcomes.

Data Points: Biotech share of Russell 2000: 25% - Used to illustrate how large biotech is in the small-cap universe despite being excluded from many screens. Specialist fund definition: >50% of portfolio in biotech - Verdad’s current operational definition of a biotech specialist fund. Number of specialist funds in dataset: About 70 - Approximate count of biotech specialist funds used in the research sample. Short-side failure rate estimate: 60–70% money losers - Greg described most biotech stocks as likely to lose money over time, supporting the case for shorting. Market-cap example in value discussion: $500 million vs $2 billion spent - Illustrative comparison showing that higher cumulative spend can imply more embedded value even if current market caps are similar. Magnitude of a biotech squeeze example: 8 to 180 - Listener example cited to show how violently a biotech short can move on positive trial news. Implied return multiple example: ~25x - Referenced as a representative extreme upside move after a surprise positive announcement. Insider purchase example: $25 million - Mentioned in relation to KKR CEO insider buying as a size discussion point.

Pivotal Quotes: "We need to go figure it out." — Dan Rasmussen: Explaining the motivation for researching biotech as a large, under-modeled part of small-cap investing. "What you actually care about is the vote of confidence from specialists relative to how many other people are invested in it." — Greg Obenchain: Describing why consensus ownership among biotech specialists is the key ownership signal. "The value metric is actually one of the most powerful return metrics we have, despite the fact that it's an incredibly simple construction." — Dan Rasmussen: Explaining why Verdad’s spend-based proxy for value works well in biotech.

Implications: Biotech can be approached systematically if investors adapt their toolkit: use specialist ownership, insider buying, spend-based value, and diversified shorting rather than standard profit multiples. The framework may improve stock selection and risk control in other hard-to-value sectors too.