D.A. Wallach Explains Why Biotech VC Is So Different

28:07That's my view. I mean, I'll steel man the other argument. The other argument would be, well, look, DA, you said 10 minutes ago that these drugs have a 5 % probability of working from the outset. If we had better predictive models that told us certain candidates were much more likely to work than others, wouldn't that be great? And my rejoinder to that is yes, but how would we know that we've done that? Meaning if the three of us tomorrow invented a black box that produced drug candidate concepts, and we were certain that our model doubled the prior probability from 5 % to 10%, that would be a truly revolutionary innovation on our part.

28:50But how many candidates from that model would we need to take all the way to an approval before we had statistically demonstrated that we in fact increased the rate of success? so people may have already cracked that code you know google may have already cracked that code sam altman may have cracked that code but someone's going to need to spend 30 billion dollars developing the drug ideas he has before we know whether he's done that and until that money is spent it's pure conjecture and salesmanship

29:40This is Steve Covino from Covino & Rich. Here to tell you, Toyota's legacy has been standing tall for generations. From pioneering hybrid technology to redefining the standards of safety and efficiency. With each innovation, a commitment to progress. And with a legendary lineup of in-stock trucks, including the ultra-rugged new Tacoma and heavy-duty half-ton Tundra, you can experience the legacy of Toyota for yourself. Visit buyatoyota.com, the official website for deals, to find out more. Toyota, let's go places.

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31:30Everybody that affects what's going on in the market, whether you own stocks, bonds, real estate, commodities, crypto, you really need to hear these conversations. Sometimes it's behaviorists like Dick Thaler or Bob Schiller. Sometimes it's fund managers like Peter Lynch, Bill Miller, Ray Dalio. Sometimes it's authors, Michael Lewis, author of The Big Short and Moneyball. Regardless of the conversation, these are the folks that move markets each week. That's the Masters in Business podcast with me, Barry Ritholtz. Listen on Apple, Spotify or wherever you get your podcasts. How are you actually evaluating opportunities in the U.S.

32:15against China competition? Because, you know, if clinical trials are the major choke point and if China seems to be trying to make that process as efficient as possible, it seems like maybe they have an advantage. I mean, they definitely have an advantage. And if I had to make a bet today on our sector, it would be that China is going to be the big story over the next decade or two. I think it's a fundamental structural shift in the global biotechnology market and their advantages are multiple. I mean, their advantages are regulatory. They relate to the personnel. We have lost an amazing amount of talent who was educated here in our graduate schools and now has gone back to China.

32:59And furthermore, they are able to develop things in the clinic, which is to say do clinical trials a lot faster and at a much higher volume than our infrastructure can handle. So they've got big advantages. Now, how do I think about investing in the US versus China? I don't that much because I don't speak Mandarin. And I think it would be really difficult for me to invest in China today. But increasingly, companies in the US are starting to outsource certain parts of the research process to Chinese companies. And increasingly, they're going to outsource parts of the clinical development process, the clinical trials to China.

33:38That's going to make a huge impact on the industry. Yeah, this was actually my next question. I guess how translatable is a successful clinical trial in China to a market like the US? Three or four years ago, what both investors and regulators in the US would have told you was that it's not that translatable because they're liars and they make up all the data and it's rampant with fraud. And there may have been some truth to that, but I think there was also a good amount of racism. And what sort of woke everyone up in the past couple of years was that some very significant clinical trials were done in China.

34:15People were suspicious of the data. Then they replicated those trials in Europe or the United States and got very similar data. And folks thought, whoa, maybe they're not so bad at this. So I think decreasingly people are skeptical and which said less awkwardly, people are trusting more and more what's coming out of China. And it's incumbent upon the Chinese to the extent that they want this to be a major strategy to continue enhancing people's trust in the quality of their work and their data. If they can do that, I think it's a global industry. A lot of the companies are multinationals. They don't care if the drug comes out of the US or comes out of China.

34:58This isn't really a question about private or VC stage investing per se, but about biotech more broadly. I've covered the stock market for a long time in various ways. I've never spent any time really getting to know a publicly traded biotech stock. Are you insane to try to invest in biotech if you don't have PhD level understanding of biology? Can anyone have alpha in this industry if they don't actually know science? I think it's tough. Yeah. Seems very tough to me. Look, here's the thing. What's really interesting about biotech in the public markets is it's abundantly clear that active investors can have alpha in biotech.

35:43Whereas as you guys know, that is not clear in the rest of the public equity landscape. And so whereas there is very little, if not negative persistence of performance among active equity managers broadly, in biotech, you have a small number of firms that have been doing great for sometimes decades. And they all have real science expertise on stuff. They do. And the dynamic between them and the generalists, so to speak, is that they do a lot of very detailed work to make sense of the information you need to process to value these companies and to assess their probability of success. And then the generalists often follow those specialists into these names.

36:28And the fortunes of the industry in these cycles, like we're coming out of a four-year Great Depression for biotech, I should just mention, a lot of those fortunes ride on the sector rotations of the generalists. So the specialists have to stick with biotech because that's what they do. But whether or not companies can IPO, whether or not companies can fund their next clinical trial is largely a function of whether the generalists are in the sector at that moment or not. And we're just in the midst of the early rotation of generalists back into biotech. Wait, the biotech investing downturn, was that just a function of higher interest rates or was something else going on?

37:11It was a confluence of everything that could go wrong at the same time. It was higher interest rates, which really punished these biotech stocks relative to other companies, because no cash flows for 10 years and then a big bolus of money. So these companies are very sensitive to discount rates. Add to that this dynamic where the generalists had gotten out of the sector, that ultimately is fatal. And then consider the fact that we had such a come down after the sugar high of COVID. So obviously during COVID, there was this moment of clarity where everyone for a second recognized that this sector is for each of us at some point in our lives, the most important thing that happens in the global economy.

37:59Like without the biotech industry, you know, we're all in trouble. And we kind of go through life pretending like we're never going to need this industry. And then you get cancer or your dad gets cancer or your kid gets some rare disease and you go, holy cow, I wish I had thought about this before. Maybe all these people who are doing this with their lives are not evil bloodsuckers who Bernie Sanders needs to take down. And, you know, that is, uh, I think part of what dawned on people during COVID when we all were vulnerable and we all were yearning for a solution. Talk a little bit more about, I guess, the, the financial incentives about actually developing new drugs.

38:41So we, we all know the story of if you're based in the U.S., you can go to Mexico or wherever else and buy the same medicine for like five bucks as opposed to five hundred dollars or perhaps even more in the U.S. And the argument for that seems to be that, well, you know, the big pharma companies need to be rewarded for all the research and the effort and the risk that they actually take on. And for some reason, the U.S. seems to be the designated place to do that. But like, why? Why is my question? Why U.S. drug pricing? Well, the big bounty for a drug development company is the United States market.

39:25And that's partly because we as a society have decided that we want all the new, most advanced drugs. We want them first, and we don't want to deny them to people who could benefit from them. Now, the price we pay for those commitments is that our drug prices are higher than the prices in other countries. And the reason their prices are lower is because their governments choose which drugs their people will have access to. And they make those choices and then negotiate the prices with the companies. And they basically will say to Pfizer or AstraZeneca, look, if you want your drugs sold here in Japan, you're going to take the price that we give you.

40:08And then the pharma company decides whether they want to accept that deal or not. Now, the United States absolutely could choose as a civilization to negotiate in that same manner. Our government could make the choice for us as to exactly what we're willing to pay for every drug. There would be two consequences to that. One is that we would go without certain drugs. The second is that a lot of drugs would not even be developed in the first place because the total pool of profits available to drug companies would be much smaller. And so I don't know that there's any perfect answer to how much pharmaceutical innovation we should have in the world.

40:53We get to choose how much innovation we want to occur. And the way we choose that is by determining the size of that bounty that exists. how big is the profit pool we want to allow for innovative drug development. And a lot of that is driven by our patent law. Remember, a patent in this industry is a legalized monopoly. So we give drug companies a legal monopoly for a limited period of time, and that dictates how much money they're able to make off of a new drug. We could shorten the patent life, and that would reduce the profit pool, and you'd have less drug development. We could remove the patent life.

41:29You could have a permanent monopoly. And believe me, the industry would double or triple overnight. So it's a choice we have to make. And it's a civic choice. You mentioned the Bernie Sanders of the world who they look at the profits of drug companies, that they look at the prices of drugs. And, you know, perhaps if they got their way, there would be less investment in drug discovery, et cetera, at all, maybe less profits. Going back to COVID, however, there was also the backlash on the other side, But essentially just this deep skepticism towards the premise of pharma and that what are these scientists doing and why don't they tell you about this route that people have used for thousands of years that cured these diseases that they don't want you to know about so that they can sell you stuff.

42:11Talk to us about like just this sort of political environment, investing in biotech in a political environment where a growing number of people frankly seem to distrust the premise of scientific expertise. Look, it's tough. And some of the blame certainly belongs with the scientific community because, you know, to the extent that say in the early days of COVID communication with the public about say the value of masks was not clear. And it was maybe even misleading. Some of the presentation of data regarding the efficacy of the vaccines was not transparent. And that eroded the public's trust in a very understandable way.

42:55Now I'm no apologist for medicine or science because I don't think these are privileged priesthoods. I think every person should be able to be engaged in and in understand science and medicine. And unfortunately the entire history of medicine began with medical science as total witchcraft and sorcery. So if you go back to antiquity, the first people calling themselves doctors objectively understood nothing. So this was pure sophistry from the beginning. And we are on this long journey through which medicine is going from total BS and witchcraft to slowly turning into a real science, something that deserves to be called science.

43:47Medicine is filled with common practices that are not rigorously based on evidence. And that is symptomatic of where we are in that journey that I'm describing. So I'm an advocate for medicine becoming always more and more scientific. I believe that scientific policymakers, scientists in academia need to do a much better job communicating transparently. And that's the only way to engender that kind of trust you're talking about, Joe. And the trust is critical because it is what gives permission to this industry's existence. Wait, talk more about, I guess, autonomy when it comes to medical decisions, because this is, you know, a big culture shock of non-Americans who come to the U.S.

44:33is drug adverts on TV where They, you know, here's this great drug and then they read off all the risk factors really, really quickly. And one of the risks is always death or severe brain damage or something like that. Suicidal tendencies. Yeah. And I'm always like, again, I've never asked for a drug that I've seen on TV. I do remember when I when I first came to the U.S. as an adult, I went to get a prescription. I found a new doctor to do that. And I said, I needed this thing. And the doctor was like, oh, well, we have to run all these medical tests before we can give you that. And it ended up in a big argument with my insurance provider.

45:14And I remember talking to people about that and they were like, well, you should have pushed back against the doctor about the testing. And I was like, what do I know? I just do what the doctor tells me. Right. How much say should people actually, it sounds weird, but given the lack of experience and given the way other systems work around the world, how much say should people have in their own medical treatment? I think ultimately they should have almost all of the say. It's your body. Ultimately, you have to make the best decision you can make. And you should regard physicians, nurses, others in the system as consultants who support you in making wise decisions.

45:53Uh, the, the one caveat there, however, is that we do socialize a lot of our medical costs and in many other countries, they completely socialize medical costs. And to the extent that you want the rest of us to pay for your medical care, I do believe we need to have some standards around what it's appropriate to pay for. Yeah. I mean, at the moment, it seems like most of those decisions are left up to the insurers, which, again, in other places in the world, it would be left up to to the governments to make those decisions. Are insurers the sort of another limiting factor here? I believe they are.

46:36I believe the private insurance industry adds zero value to the United States healthcare system, almost. I mean, I may slightly overstate it, but it's close to zero in my book. And I really don't believe insurance companies ought to be the ones making decisions about what medical care is appropriate. I noticed there in the video, you have a really nice looking microphone. Is that a musical, is that a microphone for recording music? Yeah, this is the one I sing on. First of all, you sound good, but it also looks a lot cooler than the typical microphone that our guests use. Are you still playing much music?

47:13I do, but thankfully now it's just for fun, not for money, which is a much more comfortable place for it to live in my life. Do you think at all about AI-generated music and the effect that that's going to have on musicians? I feel like a lot of musicians, like the ones that I follow on Instagram, there's a lot of anxiety about this. There is anxiety. And look, I mean, it's really hard to make a living as a musician. Now, it's always been really hard. And I can't imagine what the lifestyle was of a lute player in George II's royal court or something. But it's a tough business and it is scary when new technology comes on the scene that might change the way you make money as an artist.

48:01I lived through that with Spotify. People were terrified of it. And fortunately, what it did over time - They should have all done what you did with get long Spotify and then hedged their own risk to it. But keep going. No, but look, Spotify by multiples increased the total revenue of the recorded music business, which was the goal. So mission accomplished. Now, look, AI is going to make music. And I think like all creative people, like journalists, like investors, everyone's going to think about how they can use it to be more effective, have more leverage, have a cooler output. But I mean, I have very little doubt that artists are going to do unbelievably cool and original stuff with AI tools.

48:47And it's already happening. And for whatever reason, I have very little trepidation that they're going to be put out of business. Because I think ultimately music is communication. And real quickly on that, when you talk about like doing unbelievably cool things with music. So I see in the background, you have a piano, for example. people. And one of the things when I think about AI music is, and actually I think like, for example, the founder of Suno and some of these other AI music companies have talked about this, is like, well, music, learning to play instruments is really hard. And therefore, can we separate in some way the craft of music, the hours that someone has to spend just doing scales on the piano before they can compose something?

49:31Maybe you could, wouldn't it be nice if we could just have amazing, beautiful piano sonatas without ever having put in those thousands of hours, you know, Mary Had a Little Lamb and then so forth. But it does raise the question to my mind of whether one can create great art if they never had to learn the craft. I think the nuance with which one can communicate through music is a function of how many options you perceive. In other words, if you know the piano inside out, you're aware of so many creative choices that are at your disposal at any given moment. And if your ability to express yourself is squeezed down to what you can put into a natural language prompt, now those musical ideas are having to pass through the medium of language to be realized.

50:34And that inherently erodes the resolution and the expansiveness with which you can express yourself. I feel like there's a danger here that you go off on a big orality tangent and whether ideas can exist without words and things like that. No, but I do think that answer is very insightful. Can you actually create great piano music if you don't know the limits of what the piano can do? And if you're only trying to describe in language, make this beautiful sonata, I think that's very tough. And I thought that answer made a lot of sense. um da we're gonna have to wrap it up soon i have one last question and i'm gonna kind of i'm gonna put you on the spot can you can you sing a little odd lot song for us like three bars of an odd lot song i don't care if you generate it with you know i guess gemini now but you think you could let's see i mean oh wow i'm gonna i'm gonna turn this on let's see here this is really cool yeah if you can those who aren't watching the video so he's moving his microphone.

51:37He's moving his microphone to his keyboard. Okay. Can you see? Yeah, it's great. Yeah, go for it. Okay, we're gonna try. And it's all about, it's all about, it's all about Tracy. It's all about, it's all about, it's all about Joe. How's that? That was pretty good. You have a great voice. Yeah, it is. If you ever want to compose an outro song for us or something like that. Oh, I would love to. I am the composer of two or three podcast theme songs. And I have to say, I love your guys' theme music. It gets me excited. And I got to end on this for you guys. You know, in high school, the reason I got into investing in high school, I was an economics nerd.

52:29Oh, yeah. I heard. And my hobby. I heard that you actually wrote a paper that won a prize from the Fed or something like that. The Federal Reserve had this nerd competition they sponsored called Fed Challenge. I was the captain of my high school team one year. And we got to DC and we saw Greenspan walk out with his wizened face and hands. And anyways, if I had had odd lots to listen to in high school, man, I would have been in heaven. Because you guys touch on so much interesting stuff. and this just has to be the most exciting thing for young people to experience in order to get turned on to business and economics and finance and recognize these aren't just boring you know staid topics they're fascinating thank you for saying that i really appreciate it and also thank you for singing for us i think that was an all thoughts first yeah yeah well on the spot i know we've had um merle hazard the country singing economist on before but that was fantastic DA Wallach, thank you so much for coming on the show.

53:30Really appreciate it. Thanks, guys. Thanks for having me. Yeah, that was great.

53:45That was really interesting, Joe. That was super fun. He was great. He was also pretty good at, you know, I know, again, he said it was tenuous, but the through line from music to biotech kind of makes sense. I think it makes a lot of sense, especially the fact that these are all startup investing, as we know. There's this power law phenomenon where one of your 20 portfolio companies is going to make all the money. Yeah, the lottery ticket. But biotech is like lottery tickets upon lottery tickets. There's so much success uncertainty. Lottery tickets with lower payouts as well. With lower payouts.

54:22There's so much success uncertainty. there's so much time that elapses between the initial work and where you have see if there's any signals of traction it does feel a lot like the uncertainty that exists in the music industry and selecting like which of these hundred bands that all sound great and they're all really talented actually has what it takes to be a commercial hit a lot of parallels yeah i thought the the dinosaur bias point was an interesting one as well because you can imagine like again to the timeline point, you kind of have to be old to have any success in the industry historically, just because it can take, you know, a decade to get a particular drug to market.

55:01So you don't have that much opportunity to have, you know, those wins unless you get old. And there's no shortage. There's no, you know, there may be regulatory things that can be done. But fundamentally, if you want to know whether something works and if you want to know whether this drug is going to kill people who take it or not and whether it's safe or not. There is no substitute for doing a test and seeing what happens. And to your point or to your observation about the dinosaurs, I do think that lots of people have this fantasy that anytime there is a legacy industry of any sort, that if you just got 21-year-olds from Stanford in the same room - And gave them a garage to work out of.

55:39And gave them a garage that they would do it a lot better than the veterans. And that was the Doge premise. And Doge doesn't exist anymore. So, yeah. Shall we leave it there? Let's leave it there. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Jill Weisenthal. You can follow me at The Stalwart. Follow our guest D.A. Wallach. He's at D.A. Wallach. Follow our producers, Carmen Rodriguez at CarmenArmond. Dashiell Bennett at Dashpot and Kale Brooks at Kale Brooks. For more Odd Lots content, go to Bloomberg.com slash Odd Lots. We have a daily newsletter and all of our episodes.

56:12And you can chat about all of these topics 24-7 in our Discord, discord.gg. And if you enjoy Odd Lots, if you want us to do more healthcare episodes, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

56:44Thank you.

57:10This is Steve Covino from Covino & Rich. Here to tell you, Toyota's legacy has been standing tall for generations. From pioneering hybrid technology to redefining the standards of safety and efficiency. With each innovation, a commitment to progress. And with the legendary lineup of in-stock trucks, including the ultra-rugged new Tacoma and heavy-duty half-ton Tundra, you can experience the legacy of Toyota for yourself. Visit buyatoyota.com, the official website for deals, to find out more. Toyota, let's go places. You know what your customers are doing right this second? The exact same thing you are, listening to me.

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