Risk and Reward in the Orphan Drug Industry

Abstract

© 2019 Portfolio Management Research. All rights reserved. Thanks to a combination of scientific advances and economic incentives, the development of therapeutics to treat rare or orphan diseases has grown dramatically in recent years. With the advent of Food and Drug Administration–approved gene therapies and the promise of gene editing, many experts believe we are at an inflection point in dealing with these afflictions. In this article, the authors propose to document this inflection point by measuring the risk and reward of investing in the orphan drug industry. They construct a stock market index of 39 publicly traded companies that specialize in developing drugs for orphan diseases and compare the financial performance of this index, which they call ORF, to the broader biopharmaceutical industry and the overall stock market from 2000 to 2015. Although the authors report that ORF underperformed other biopharma companies and the overall stock market in the early 2000s, its performance has improved over time: from 2010 to 2015, ORF returned 608%, far exceeding the 317%, 320%, and 305% returns of the SP, NASDAQ, and NYSE ARCA Biotech indexes, respectively, and the 83% of the SP 500. ORF does have higher volatility than the other indexes but still outperforms even on a risk-adjusted basis, with a Sharpe ratio of 1.24 versus Sharpe ratios of 1.17, 1.14, and 1.05, respectively, for the other three biotech indexes and 0.71 for the SP 500. However, ORF has a market beta of 1.16, which suggests significant correlation to the aggregate stock market and less diversification benefits than traditional pharmaceutical investments.