Financing Correlated Drug Development Projects

Current business models have struggled to support early-stage drug development. In this paper, we study an alternative financing model, the megafund structure, to fund drug discovery. We extend the framework proposed in previous studies to account for correlation between phase transitions in drug development projects, thus making the model a more realistic representation of biopharma research and development. In addition, we update the parameters used in our simulation with more recent estimates of the probability of success (PoS). We find that the performance of the megafund becomes less attractive when correlation between projects is introduced. However, the risk of default and the expected returns of the vanilla megafund remain promising even under moderate levels of correlation. In addition, we find that a leveraged megafund outperforms an equity-only structure over a wide range of assumptions about correlation and PoS. TOPICS: Portfolio theory, portfolio construction, equity portfolio management, asset-backed securities (ABS), mutual funds/passive investing/indexing, simulations, performance measurement Key Findings • The performance of a biomedical megafund becomes less attractive when correlation between phase transitions in drug development projects is introduced. • The risk of default and the expected returns of the vanilla megafund remain promising to fixed-income investors and equity holders, even under moderate levels of correlation. • A leveraged megafund outperforms an equity-only structure over a wide range of assumptions about correlation and probability of success.