A super way to invest in biotech

What are the odds that Australians' precious nest eggs be used to invest in something as risky as biotech? Well guess what -- it's already happening, and governments face pressure to free up more superannuation funds, writes Ruth Beran.

With the biotechnology industry facing a lack of capital, questions are being raised as to whether the deep coffers of superannuation funds could provide a possible solution.

State and federal governments have been lobbied by high-profile groups (including, most recently, the Committee for Melbourne, in a very public campaign in The Age newspaper) to invest superannuation funds in biotechnology.

Investing in biotech can lead to big rewards. But it also carries substantial risks, and that, together with a lack of understanding of the sector, has kept investment in biotech small. Releasing super funds, so the argument goes, will in turn boost the skill levels of the financial gatekeepers in the investment sector, as well as biotech managers, and raise awareness of the sector overall.

For many in the biotech sector, including CSIRO's executive director of business development and commercialisation Nigel Poole, it's frustrating to see billions of would-be investment dollars floating tantalisingly out of reach. "How can we attract more money and capability when the invisible hand [of capital allocation] is at work elsewhere?" he asked of a recent conference. "Can a manager add value to 20 or 30 early-stage investments? Will successful early-stage investors, like GBS Ventures or Start-Up Australia, move to the big end of town?"

Filling a need

But there appears to be increasing support for the super fund argument, and it's backed up by example. The government of the Australian Capital Territory, for instance, has partnered with the Motor Trades Association of Australia (MTAA) Superannuation Fund and the Australian National University (ANU) to commercialise research projects, including biotechnology, coming out of the ANU and other ACT institutions.

"One of the gaps we perceive in building our knowledge for an innovative economy is the absence of venture capital," explains the ACT's minister for economic development and business Ted Quinlan. "Our idea was to fill a need."

The $30 million ANU/MTAA Super Venture Capital Partnership established earlier this year saw MTAA Super investing $20 million as part of its alternative asset portfolio and the ACT government providing a repayable grant of $10 million. Quinlan says that by that decision, the ACT government now becomes "the most patient of investors".

"I have expectations that some years out, because it will take some time, this fund will be quite successful just because of the pool of research and ideas and innovation that it has to dip into," he says.

Delicate position

But what role should governments play in unlocking the vast amounts of cash sitting in superannuation funds, making them available for venture capital investments in biotechnology?

Tim Murphy, executive director of the BioMelbourne Network, believes that the federal and Victorian governments should intervene to "assist and induce the institutional investors to look at this sector more".

In a joint submission to the ongoing Australian Venture Capital Review, the Committee for Melbourne and the BioMelbourne Network recommended that for a period of three to five years, the federal government should support the differential return between venture capital of 7 per cent and the much higher return of 12 per cent that institutions receive from other investments.

"Primarily, we're targeting the super funds," says Murphy. "[Cumulatively] they're the fourth largest funds under management in the world, and a trickle is going into VC. We're saying we want them to allocate more to VC, and naturally that would lead on to biotech."

However, governments are likely to be cautious in interfering with the way in which superannuation funds invest money.

"What we're talking about here is people's savings, and the decisions that are taken by the super funds have obviously got to be taken in the best interests of the investors," says the ACT government's Quinlan. "My government would not want to impose itself between the motive and the interests of the investors and how the fund operates."

Bob Moses, a veteran player in the Australian biotech industry, says that without some government pressure or incentive, superannuation fund managers are likely to be reluctant to invest in the more speculative areas of the industry for two reasons. "One, it requires particular analytical skills that understand biotech and are willing to spend the time to sort out the quality from the inferior quality," he says. "Secondly, the superannuation funds have annual evaluation. If the valuation doesn't take into account that investments in biotech can take many years to realise value, then there is pressure to turn over those investments."

Moses says he would be in favour of some incentive to encourage superannuation funds that invest long term to do so in the biotechnology sector. But, he says, "I'm not holding out great hope, nor am I expecting that it's likely to happen in the near future."

Looking westward

Besides the ACT, there's another local example of superannuation-biotech partnerships that is attracting attention. Western Australia's largest private sector superannuation fund, Westscheme, now has more than $20 million invested in biotechnology, according to the fund's private equity advisor, Paul Sheever of Access Economics.

And, allaying fears that super funds will be the most conservative of investors, Westscheme isn't starry-eyed about what it's getting into. "We know that there will be investments that won't succeed and we have every expectation that there will be investments that will succeed extremely well," Sheever says. "Our expectation is that they will have reasonable pay-off over time."

Westscheme has invested in life science venture capital funds GBS Venture Partners, Starfish Ventures and CM Capital. It also initiated the Perth-based Murdoch Westscheme Enterprise Partnership (which recently supported Dimerix Bioscience's series A capital raising) and is a partner in the Universities of Queensland, Melbourne and New South Wales' pre-seed venture fund UniSeed.

"We like to keep our individual venture exposure within Westscheme's portfolio down to a basis point or a few basis points. That means $0.01 to $0.03 for each $100 of portfolio," says Sheever.

Westscheme's venture portfolio is geared towards unlisted companies, says Sheever, but the managers will often stay with the companies because "sometimes listing isn't necessarily the end of the transaction".

For example, Westscheme is an investor in listed biotech Pharmaxis (ASX:PXS). "It's a great company with a great future. We think we have some more like that coming through in our portfolio," says Sheever. But generally, investment in listed companies is the realm of Westscheme's mainstream equity managers rather than venture managers.

Sheever says Westscheme's investments in early-stage biotechnology differentiate it somewhat from similar organisations. "Regrettably, there is a desire by superannuation trustees to protect themselves by only investing where there is some highly demonstrated history of past performance. In venture capital in Australia that is difficult," he says.

'Moral hazard'

But Sheever doesn't believe governments should provide incentives or direct superannuation companies to invest in biotechnology to address this gap. Giving money back to superannuation funds that invest in biotechnology, even if they invest poorly, is a reduction in 'moral hazard', he says, and would result in funds investing in the highest risk projects, not necessarily the best projects. "I think that investment decisions should be driven by sound reasoning, prudent policy, good judgment and good strategy. Not by tax concessions or the reduction of moral hazard," he says. "Investors still need to make risk decisions."

Nonetheless, Sheever does support government incentives to raise skill levels in the sector "because the dollars will follow the skill".

Starfish Ventures investment principal Michael Panaccio holds a similar view. "You can't have a whole lot of additional capital arrive into the market and assume that it's going to be employed efficiently," he says.

Panaccio also sees the small pool of management expertise as the limiting factor for the biotechnology sector. "What is needed, on one side of the fence, is more experienced venture capital managers who can employ capital efficiently," he says. "Secondly, within the underlining investee companies you need the right type of management teams that can go out and build global companies."

Funds will invest wherever they can get returns, Panaccio says. "So long as we build strong robust companies, super funds will invest more and more."

Alison Coutts, director of research at Sydney-based investment bank EG Capital, agrees. The whole investment base, Coutts says, needs to learn more about biotech. "One of the reasons that a lot of professional investors don't go near the sector is because they don't understand it. It is inherently volatile and risky."

Skills lacking

A report prepared by the Boston Consulting Group for the Committee for Melbourne, released in July, also found that lack of skills is a major obstacle to biotech companies' efforts to get expansion capital. Among the barriers identified in the 'Expansion Capital for Innovation' taskforce report were a lack of confidence in biotech company manager's commercial capabilities, a lack of biotech skills and experience among institutional investors, and no critical mass of experienced venture capitalists.

"What we found is that because the biotech sector is a relatively new sector, and seen as a high-risk sector by the investment communities -- particularly the super funds which have a more conservative profile -- there's a significant gap of knowledge amongst the superannuation funds about the nature of biotech investments," says Boston Consulting's Melbourne senior vice-president Danny Dale. "That's why we recommended that if the government was looking at intervention or investment they should look at how they can support, or even subsidise the superannuation sector, to invest in gaining that knowledge."

If it takes a hand in addressing this skills imbalance, government will break the deadlock in the sector, Dale says. Meanwhile, it's Catch-22: "Until you start getting volume through, no one's going to invest in getting those capabilities. And you're not going to get the volume until they've got the capabilities."

ABN Amro Morgans senior analyst Scott Power also sees investment in the biotechnology industry as a chicken and egg problem. "If you have more money, you will attract better managers," he says, adding that allocating a small portion of superannuation funds and managing that properly would be "positive" for the sector.

Mandate for improvement

Mandating that a certain percentage of funds be allocated to the sector is one way to ensure that superannuation funds invest in biotechnology. Prima Biomed (ASX:PRR) chairman Eugene Kopp, a former public master trust board member, is a strong advocate for this sort of government intervention.

"There is a significant disparity between the billions of dollars that are coming into the superannuation industry and the investment in what I consider to be one of the very critical sectors in the Australian economy," Kopp says. "The government needs to encourage investment by literally insisting that certain percentages of super funds are invested in this type of high-risk, and nationally important, sector."

By legislating that a certain proportion (between 0.5 and 1 per cent, say) of master trust and superannuation funds must be invested in biotechnology, Kopp says those funds would have no choice but to bring in advisors and analysts with appropriate skills.

"There are probably about four or five dedicated analysts in this nano-cap sector. That's pretty abysmal," he says.

BioDiem (ASX:BDM) managing director Tom Williams, a former funds manager for HSBC, also thinks that government should regulate a small percentage of superannuation funds to be directed towards early enterprise investments, particularly in the biotech industry.

The conflict, he says, is that superannuation funds have a three- or six-month outlook, but most Australian biotechnology companies are at such an early stage in their development that they can't compete given this short-term focus. "But if the government is interested in building an industry, then you do require long-term capital, so you can wait five to 10 years for a reasonable prospect of a return," says Williams.

Another issue is that most venture capital funds only invest in unlisted companies. "I think in Australia the need is for more funds for listed companies as well," Williams says.

Matter of degree

EG Capital's Brad Ross-Sampson says the difference between listed and unlisted companies in the biotechnology sector is a matter of definition, with many listed companies exhibiting similar characteristics to the types of unlisted companies in which VCs would invest.

However, he says, mandatory allocation of superannuation funds into biotechnology is not necessarily a great idea.

"I think investments should stand up on their own merits," he says. "It's up to the actual fund managers, and obviously the investee companies, to convince the pension funds that by investing in the sector they're going to deliver returns and therefore returns to the unit holders of their respective super funds."

Meanwhile, CSIRO's Poole told a conference in Sydney last month, when it comes to attracting superannuation funds to biotech, the best approach may yet be a personal one. "When you meet a gatekeeper, shake their hand!" he said. "They control between $50 million and $100 million each. They are thinking about investing in early-stage technology, and they're going to ask 'tell me the return profile' -- and of course we can't."

Pharmaxis CEO Alan Robertson, whose company successfully attracted the attention of Westscheme, agrees. "Go and knock on doors and ask them," he told the same conference. "Part of it is our fault -- we have not provided a healthy return on investment."