Summary

Andrew Lo, Professor of Finance, and the Director of the Laboratory for Financial Engineering at the MIT Sloan School of Management, sits down with Neil to discuss his application of portfolio theory to address the challenges of funding drug development and how a Netflix subscription model can address the coming crisis in funding high-priced curative therapies approaching the market.

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Transcript

00:35
Neil Littman (Host)
I am incredibly excited to welcome Andrew Lowe to the show today. He is a professor of finance and the director of the Laboratory of Financial Engineering at the MIT Sloan School of Management. Andrew's research spans three areas evolutionary models of investor behavior and adaptive markets, artificial intelligence and financial technology, and healthcare finance. Today, we're going to focus on Andrew's work around this last topic, healthcare finance, and in particular, his work related to accelerating biomedical innovation via novel business financing and payment models. Dr. Lowe has published extensively and won numerous academic awards. I'm not going to list those all here at the moment. They'll all be provided in our show notes as well as a link to Andrew's full biography. I think it's important to note that Andrew is both a member of the New York Federal Reserve's Board of Financial Advisory Roundtable.

01:35
Neil Littman (Host)
He is a member of the National Academy of Sciences Board on Mathematical Sciences and their applications. He's also on the boards of Royvant Sciences and the Whitehead Institute for Biomedical Research. He's a co founder of Bridge Bio. And so you can tell just based on his board memberships, he spans both finance and the healthcare and biotech worlds. And so he brings a really unique perspective to novel ways to finance biomedical innovation, which is going to be the topic of today's discussion.

02:05
Danny Levine (Co-host)
Andrew's applied portfolio theory to biotech financing. He seemed to capture the imagination of a lot of people when he first wrote about this. I know we're going to take a deep dive here, but what was at the heart of his argument?

02:19
Neil Littman (Host)
So Andrew pioneered this concept of how portfolio diversification would allow novel business models and financing models to emerge to bridge what is often called the Valley of Death and biomedical innovation. And so, just as a brief example, I'll get into this with Andrew, so I'll just touch upon it. He pioneered this concept of the Cancer Mega Fund, which is about a $30 billion fund that would have a portfolio of around 150 therapies within that portfolio, which would create a nice, diversified, risk adjusted return profile for that fund. And by doing so, you could actually attract much larger and different pools of capital than what are often thought of pools of capital that traditionally fund research. And so that was a seminal paper that I think was published back in 2012.

03:12
Neil Littman (Host)
Initially, that was very inspirational for me as I thought about how to provide innovative sources of funding for biomedical innovation and for biotech companies. He's also a co founder of Bridge Bio, which has really taken that step and applied that scary to the world of rare diseases. So Bridge Bio has built this, what's often called the hub and spoke model, where they have built a portfolio of 15 to 20 uncorrelated assets within their portfolio, which, again, is really supposed to, from a financial perspective, give them a nice risk adjusted return because all of those assets are uncorrelated. So the success or failure of any one product within their pipeline shouldn't affect the success of any other product in their pipeline. And Bridge bio has been very successful. They've raised a lot of money. They went public.

04:03
Neil Littman (Host)
I think they have about a $4 billion market cap. So I want to talk to Andrew about both theory and execution of that theory that he's seen over the years.

04:11
Danny Levine (Co-host)
What else are you hoping to hear from him today?

04:13
Neil Littman (Host)
Well, I want to talk about this novel payment model that he has pioneered as well. So he recently published some work around this concept of the Netflix subscription model being applied to the healthcare payment system. So there has been an emergence of curative cell and gene therapies in recent years, and those therapies often have a very high price tag, a million, $2 million. And so there is a lot of concern from the Payer community that those high price tags, when those therapies are applied to large markets, large patient populations, could really break the bank, so to speak. And so Andrew has applied really novel financing mechanisms to make it more of a subscription based model as opposed to a one time payment and to really help spread the risk around to different payers or to different stakeholders.

05:11
Neil Littman (Host)
And so I'm really excited to talk to Andrew and dive into that model as well.

05:15
Danny Levine (Co-host)
Well, if you're all set, let's do it.

05:17
Neil Littman (Host)
Danny andrew, thank you for joining us today. I am incredibly excited to welcome you to the show.

05:26
Dr. Andrew Lo (Guest)
Thanks for having me, Neil.

05:27
Neil Littman (Host)
My pleasure. So today we are going to talk about financial theory, how your application of it has been put into practice, and what the next frontier may look like for how we pay for high priced genetic medicines. I'd like to start on a personal note, though, with how and maybe more importantly, why, given that you're an economist and a professor of finance at MIT Sloan School of Management, you came to think about the problems of drug development. I understand this was a personal matter for you. What happened?

05:57
Dr. Andrew Lo (Guest)
Well, what happened, I guess, is life. About 15 years ago, a number of friends and family were dealing with various kinds of cancer. And in the space of six years, I lost five people close to me from various kinds of cancer. And that was a really big shock, a wake up call. And so it was during that process that I realized that a cancer patient needs a financial economist about as much as a fish needs a 401K plan. And I felt pretty useless. So I decided to spend more of my time focusing on how cancer drugs get developed and what financial economists can do to make that process more efficient.

06:37
Neil Littman (Host)
Andrew, in 2021, you wrote a paper called Can Financial Economics Cure Cancer? And you mentioned that biomedicine is at an inflection point. Before we dive into what you mean by that. Specifically, you share what I found to be a really powerful story at the end of the paper about one of your MIT colleagues, Harvey Lotus, which really resonated with me. Can you share the story? Because I think it really helps set the stage for a lot of your work and will help set the stage for our discussion today.

07:13
Dr. Andrew Lo (Guest)
I'd be happy to. And that was actually a transformational moment for me as well. So Harvey is a biologist by training and trade. He's at the MIT Whitehead Institute for Biomedical Research. And when I first learned of Harvey's story, I decided right then and there I wanted to be Harvey Lotish. And when I tell you why, you're going to want to be Harvey, too. In 1983, Harvey was an assistant professor here at MIT, and some of his colleagues asked if he would be willing to help them with a particular disease known as Gauche Syndrome. They were thinking about developing a new therapy to treat it. And it's a rare condition that is not that rare among rare diseases single gene mutation that prevents your body from producing some pretty important housekeeping enzymes.

08:02
Dr. Andrew Lo (Guest)
And without it, by the time you become a teenager, if you've got a particularly serious variant of the disease, you're dead. And so Harvey and his colleagues decided back in 1983 that they would start up a biotech company to try to address this unmet need. And over the course of a few years, they came to develop what was then the first enzyme replacement therapy. And in 1991, the drug Serradase was approved. And since that time, they've been able to help hundreds of thousands of patients with that drug and the various different improvements on it. And you may have heard of Harvey's little startup. It's called genzyme. And in 2011, it was purchased by Sonofi for $20 billion. Now, that's great, but that's not why I want to be Harvey Lotus, although it's not a bad reason.

08:53
Dr. Andrew Lo (Guest)
I want to be Harvey because of what happened in 2002. In that year, Harvey's daughter was pregnant with her second child, Harvey, and his wife's second grandchild, a boy named Andrew. Great name, by the way. Andrew was born with Gauche syndrome. And when I heard that, I talked to Harvey. It was a very emotional conversation. I asked him, Harvey, did you know in 1983 that you would be working on a drug that would one day save the life of your as yet unborn grandson? And he said, I had no idea. 1983 was basically 20 years before we even sequenced the human genome. So he said, I had no idea that I was carrying the mutation.

09:46
Dr. Andrew Lo (Guest)
And he felt that if he were able to do some cool science and help some patients, that would be great, but never expecting that the drug would actually save his grandson's life. And when Andrew turned ten in 2012, he did develop the full blown symptoms of Gauches, but he's doing just fine leading a totally normal life, thanks to the drug that Grandpa helped to develop. And that's why I want to be Harvey Lotish, but I don't have a PhD in molecular biology. I will never be able to develop a drug that will save the life of my as yet unborn grandchildren. But I realized then that we can all be Harvey Lotus if we end up investing in the drugs that save the lives of Varia's yet uncorn grandchildren.

10:32
Neil Littman (Host)
Andrew, it's such an incredible and powerful story. I don't know what the odds of that situation actually happening are probably pretty low, but it's just a powerful story. And I think, really, to me, resonated that theme carries through so much of your work in terms of applying economics and finance to biomedical innovation. And so I want to use that as a jumping off point and go back to that question that I mentioned before that you cited in your recent paper, that this idea that biomedicine is at an inflection point. What do you mean by that?

11:12
Dr. Andrew Lo (Guest)
Well, that's a term that comes from the insiders in the industry. And so in talking with them, I began to realize that we are not living through normal times right now in healthcare. And the way that the insiders describe it is convergence. My colleagues Susan Hockfield, Tyler Jackson, Phil Sharp published a monograph in 2016 titled Convergence of the Life Sciences, engineering and the Physical Sciences. And what they're talking about is the fact that in all of these different fields, these various different breakthroughs that have been happening over the course of the last few years are coming together to give us novel ways of treating various kinds of human diseases and in a number of cases, literally curing the disease. Most doctors and scientists don't use the C word cure because they realize that disease can come back with a vengeance.

12:07
Dr. Andrew Lo (Guest)
But the fact is that they are using it now because they're beginning to unlock the secrets of the origins of disease and then being able to develop therapies that deal directly with those mechanisms to interfere with the mechanisms of disease and actually cure patients from some of the most deadly versions. So that's what inflection means. It means that we're living through a renaissance of incredible discoveries almost week by week. And that is both heartening, but it's also frustrating because it turns out that we don't have all of the financial resources we need to take advantage of this renaissance.

12:46
Neil Littman (Host)
Yeah, and I want to dive into that last point, but for our listeners, a quick aside, that paper that you referenced talking about the convergence of these various disciplines was a seminal paper in my world that I read and had a profound impact. And in fact, I got the name of Bioverge thinking about the convergence of biology with many of these different technologies and different disciplines. So for those of you in the audience that haven't read it, great paper. Andrew, I want to go back to this idea between what was once thought to be science fiction is now more routinely becoming science back.

13:23
Neil Littman (Host)
This idea that we're able to increasingly cure diseases that were once thought to be incurable but there still seems to be a major problem in translating science and moving therapies from the discovery stage to the proof of concept stage, a golf that unfortunately is named the Valley of Death. And you've come to view this more from a financial perspective rather than a scientific problem. How did you come to think about this from that approach?

13:56
Dr. Andrew Lo (Guest)
Well, to somebody with a camera, I guess everything looks like a nail. I'm guilty of that as well. When I first heard about the Valley of Death, first of all I was wondering where is this Valley of Death? Are we talking about southern California? Where is this? And the more I talked to experts, the more I began to understand that this is really a metaphysical location that applies to all of biotech, where the process by taking ideas out of the research laboratories and bringing them into clinics where they can benefit patients, that's the value of death. The early stages of drug discovery often called preclinical or pre phase one discovery. And at first I didn't understand why there was a value of death.

14:43
Dr. Andrew Lo (Guest)
My naive assumption at the time was that if there are some patients in need and there's medical expertise that can help those patients, then magically money should appear to deal with this problem and eventually get a drug developed. And the more I talk to the experts in the field, the more I realize that the truth is nothing like this and that there's a really big struggle for getting funding at the early stages of drug discovery, hence the Valley of Death. And so as I started doing more research into the origins of this particular phenomenon, I realized that it actually had to do with risk, particularly financial risk. There's always scientific risk. You never know whether or not something is going to work in practice because the human body is very complicated. But it turns out that scientific risk also has consequences for financing.

15:39
Dr. Andrew Lo (Guest)
And so the Valley of Death, from my perspective as an economist, is really more about how to deal with the financial risks of early stage drug discovery. And that's when all of the tools that I developed for portfolio theory and hedge fund strategies, the kinds of things that financial economists spend time on, could also be applied to managing portfolios of biomedical assets.

16:03
Neil Littman (Host)
So Andrew, let's dive into that piece. So in 2012 you co authored a paper, Nature Biotechnology, that the solution to this problem rested in applying portfolio theory to biomedical innovation. And you presented an idea in that paper around this concept of creating a I think it was a $30 billion mega fund focused on cancer therapeutics. And by building a diversified range of assets within that portfolio across different stages, you could build an attractive portfolio from a risk adjusted basis where any one asset would largely be independent of the success or failure of another asset within that portfolio. And by doing that, you could create novel financing structures to bring more capital and increase the pool of capital that would be available for drug development. Could you walk us through that thesis and that MegaFun concept?

17:02
Dr. Andrew Lo (Guest)
Sure, I'd be happy to. So at the time when I started writing about these kinds of ideas, I knew very little about biomedicine, and I owned up to that. My goal was to try to figure out ways of helping cancer patients based upon the tools that I was familiar with. And one of those tools was portfolio theory. I heard from experts in cancer that it's really hard to develop a cancer drug because it's cost a lot of money, it takes a lot of time, and the probability of success historically has been pretty low. In oncology in particular, the probability that you will successfully develop a cancer drug is something on the order of 5%. Actually, historically, it's a little bit less than that. And so if you think about the failure rate as 95%, that's pretty tough odds for any investor to take on.

17:52
Dr. Andrew Lo (Guest)
And so the natural reaction that a financial economist has to the situation is, well, if each of these investments is really risky, the answer is don't invest in just one of them. Invest in a whole bunch of them all at the same time. And that approach only works if by doing so, you not only increase the odds of at least one or two successes, but if it's also the case that those one or two successes will generate enough value to pay for the other failures and for many kinds of investments, that's not true. But for drug development, and specifically for cancer drug development, it is absolutely true.

18:33
Dr. Andrew Lo (Guest)
If you invest in 150 cancer projects and you end up spending large amounts of money to do that and you only have a couple of winners, those two winners are enough to justify the expenditures on the remaining 148 losers. That is the calculus that I did back in 2012 when I published the paper with my colleagues. We basically did a statistical analysis and then used the computer simulation to take a look at what a big mega fund portfolio would look like. And at the time, the largest venture capital fund was, I think, maybe a billion dollars. And so the idea of 15 or $30 billion just seemed insane. But it turns out that I didn't get the numbers out of the air.

19:22
Dr. Andrew Lo (Guest)
The reason we came up with those numbers was because we knew how much it cost to develop a single cancer drug on the order of $200 million to run the clinical trials. And if you want to diversify across a large enough number in order to guarantee, to a reasonable degree of probability a couple of successes, those are the kind of numbers that come out of the analysis. So that was the nature of the publication, and there was a lot of moving parts. But I had the benefit that I've seen this happen in other parts of the financial sector. In fact, the whole mortgage backed securities markets really grew from this very same set of considerations. So I just simply applied the tools that I knew from other parts of finance and applied it to cancer drug development.

20:08
Neil Littman (Host)
Andrew, could you explain how this would be different from a typical venture fund? Obviously, the scale is one component. What you're talking about is a much larger scale than a typical VC fund. But my understanding is to do something on this order of magnitude actually increases the pool of capital that could actually invest in this type of fund.

20:29
Dr. Andrew Lo (Guest)
Could you talk a little bit about that as well? Sure. So it differs in a few different ways. Obviously there are some similarities because if you look at a venture capital fund, if you look at a pharma company, they kind of look like mega funds. But there are some pretty important differences. I guess the first difference is the scale. As you mentioned, you really need much larger scale than what's going on in the industry, or rather what went on in the industry back in 2012. I think since then we've actually seen funds and companies that have been created to capture that kind of scale. So I certainly can't take credit for that. But I do think that the research that my colleagues and I have done motivated a number of entrepreneurs and venture capitalists to raise more money than they otherwise might have intended.

21:19
Dr. Andrew Lo (Guest)
And so that's the first big lesson. You need scale in this business. The second area where it differs is that what we're talking about is investing financially in these various different assets. That's not the same thing as creating a pharma company with all the layers of bureaucracy that come with it, because you can create a much more streamlined organization while at the same time giving investors that financial diversification. So in other words, it's separating the particular business model of a biopharma company from the financing model that generates the funding that company needs. I think that you can be very creative with the financing while still using some of the more traditional ways of organizing companies. But it turns out that the new financing has actually motivated new organizational structures as well. And the third difference is you put your finger on it.

22:21
Dr. Andrew Lo (Guest)
It's the nature of the investors. So traditionally the kind of investors that put money to work in this space is venture capitalists in the biotech field. So we're talking about entrepreneurs as well as investors that are deeply steeped in the science and medicine of human disease. Typically, the head of a biotech VC fund will be an MD, PhD that used to work in Big Pharma or started out as an investment banker and ultimately decided that they wanted to start making direct investments in these various different therapeutic companies. What we're talking about is a very different structure from the point of view of a mega fund, where you're now getting a very broad set of investors that perhaps know nothing about biotech, but ultimately would like to bet on healthcare in a broad and diversified way.

23:20
Dr. Andrew Lo (Guest)
And some of those investors are willing to take lots of risk, like hedge funds, but some of those investors are not willing to take a lot of risk, like mutual fund investors. And so the question is, can you come up with a financial model that allows all these investors to be able to participate investing in healthcare while at the same time allowing them to take only the amount of risk that they're comfortable taking? And that's really what the mega fund also does. It creates these multiple tranches, to use a term from the commercial mortgage backed securities market, where you can have a high risk tranche if you're looking for higher returns and looking to take on higher risk, or a low risk tranche, where if you're a money market fund, you don't want any risk.

24:05
Dr. Andrew Lo (Guest)
It's possible to invest in healthcare even in that context using this kind of structure. So that's really where the financial engineering comes from. It really relies on the ability to structure an investment into these multiple compartments, different levels of risk and return, and allow a broader set of investors to come in and provide support for the healthcare space.

24:31
Neil Littman (Host)
And Andrew, you mentioned that your work was hopefully inspiring some new business models and new entrepreneurs. And in fact, your work did strike a chord with a former student of yours, Neil Kumar. And through the work you did together, I think you're one of the co founders of Bridge Bio, right, where you have been applying this model to development in the rare disease space. Could you talk a little bit about the concept of applying this cancer mega fund model to the area of rare diseases and this concept behind what Bridge Bio is now doing?

25:10
Dr. Andrew Lo (Guest)
Sure, happy to. Yeah, I'd be happy to. I first became interested in rare diseases through Harvey Lotich because, of course, Gauche syndrome is a rare disease. And initially you might think, why do we care about rare diseases? By definition, they affect a small number of patients. So it's not really as important as heart disease, for example. Right? And it turns out that's not right because although any given rare disease may affect a relatively small patient population, the fact is that there are over 7000 rare diseases that we know of there may be more that we don't know of yet. And across those 7000 diseases, there are over 30 million Americans that are suffering from one of them today. That's more than the number of cancer patients that there are in this country. So as a group, rare diseases is actually not that rare.

26:04
Dr. Andrew Lo (Guest)
But I got interested in writing about rare diseases more because of a peculiar financial aspect and that's ultimately what reconnected me with my former student Neil. The aspect has to do with correlation. I think we all understand intuitively what correlation means. Don't put all your eggs in one basket. That's an aspect of correlation that we incorporate into our investment process because obviously, as long as you have multiple investments that are not all perfectly correlated, then while one part of your investment may be down, most likely a well diversified portfolio will mean that other parts of your investment are doing well. The idea behind managing correlations is really one of the key pillars of modern financial management. And so I started thinking about how to manage correlations.

27:00
Dr. Andrew Lo (Guest)
If you invest in five different cancer drug development projects and they're all targeting the same mechanism of action, let's say angiogenesis inhibitors. These are drugs that prevent blood vessels from growing in tumors. If you've got five angiogenesis inhibitors in your portfolio and they're all targeting the same mechanism of blood vessel development and one of those five projects fails, it's probably not good news for the other four. And so that's an example where correlation is not your friend. You want to minimize it if possible. And so how do you minimize that? I started looking into the statistics of these various disease successes and failures and I realized that rare diseases presents a really unusual investment opportunity.

27:49
Dr. Andrew Lo (Guest)
And the opportunity is this because there are so many different rare diseases and because they're so different in many cases from how they work, the success or failure of one rare disease therapeutic development program is generally not always, but generally relatively uncorrelated with the successor failure of a different rare disease therapeutic program. So this is a very special feature of rare diseases that doesn't apply to many other kinds of drug development programs. And the reason that this is important is that the more uncorrelated projects you have in a portfolio, the greater is the amount of risk reduction. And the way I illustrate that to my MBA students is I often give them a challenge. And the challenge is this can you name five financial investments across any particular market you want? It doesn't matter. Stocks, bonds, currencies, commodities, real estate, infrastructure, natural resources.

28:56
Dr. Andrew Lo (Guest)
I don't care what strategies or assets you pick. Can you name five financial investments that are each pairwise uncorrelated with each other? And my guess is you can't. I've tried this with all of my MBA students over the course of the last 20 years. Not a single one of them has ever been able to come up with five. In some cases, they're able to name two three. For example, it used to be that investing in foreign currencies was unrelated to investments in the US. Stock market. By the way, that's no longer true anymore. It used to be the case that investing in natural resources was uncorrelated with investing in fixed income securities. That's no longer true. So the problem in finance is that all of the investments that we tend to make, they're all related to each other.

29:48
Dr. Andrew Lo (Guest)
And that means that when we combine them into a portfolio, the risk reduction is not particularly impressive. Well, I can name five. In fact, I can name 20 rare disease drug development programs where any one successor failure has literally nothing to do with the successor failure of the other 19. And what that means is that you can reduce the risk dramatically by putting together just a portfolio of 15 or 20 of these projects. So in my cancer illustrations, I often use much larger numbers for the portfolio of 50 to 100. But with a rare disease portfolio, you only need ten or 20.

30:33
Dr. Andrew Lo (Guest)
And so I published a paper focusing on rare diseases as an asset class and pointing out that if you construct a portfolio of ten or 20 of these companies, well, then it actually will give you a very attractive rate of return at a relatively modest amount of risk. In some cases, giving you a better risk adjusted return than many hedge funds that are out there. So I published this paper, and so I published this paper, and I received a phone call from a former student of mine. He had been a PhD student at MIT in chemical engineering, but he took one of my finance courses when he was here. And he called me up and said, professor Lowe, I read your paper on rare diseases.

31:17
Dr. Andrew Lo (Guest)
I'm really interested in this, and I was wondering if you'd mind rerunning your computer simulations, not with your assumptions about success and failure and probabilities and the costs and benefits, but if you would use my numbers instead. And so I said to Neil Kumar, the former student of mine, sure, Neil, I'd be happy to do that. I'm always looking to learn from industry experts. And at the time, Neil was a venture capitalist in biotech and making investments based upon these kinds of calculations. So over the course of five or six months, we must have run, I don't know, 30 different simulations each time getting results that were better and better in terms of their risk adjusted return. Neil would suggest a few ideas. I would throw in a few tweaks. And very quickly it became clear that this business model could actually work.

32:14
Dr. Andrew Lo (Guest)
And so one day, Neil came into my office and said, I just want to let you know I quit my job yesterday. I'm going to do this. I'm going to build this company. I have to tell. You. That scared the heck out of me. I'd never had that effect on any of my former students. And I said to Neil, Look, Neil, you have a young kid at home. You sure you want me to run a few more simulations before you quit your job? And he no, I'm really excited about so that was how Bridge Buy was formed. I felt guilty enough that I put some money into the Friends and Family Round. In retrospect, I wish I had put a lot more money in, because that company has done quite well, is now worth about $4 billion in market cap.

32:58
Dr. Andrew Lo (Guest)
But that's not what they're most proud of. Obviously, the investors have done really well, but what they're most proud of is that this little tiny company now has 20 different drug development programs. Two approved drugs through the FDA, a third one that is looking really good and has got very strong phase three results. And a lot of patients that are being helped that otherwise wouldn't have, because these diseases individually are rare enough that Big Pharma wasn't interested in taking them all the way to FDA approval. But in a portfolio of ten or 20 of these drugs, it looks very attractive from the shareholders perspective. And patients are therefore being treated that otherwise wouldn't have. That's what they're most proud of.

33:49
Neil Littman (Host)
Andrew, picking up on that last point. In terms of building a diversified portfolio of largely uncorrelated assets, bridge Bio's stock has both tumbled and soared based on single clinical trial results. Has that surprised you at all, or would you expect that with this model?

34:10
Dr. Andrew Lo (Guest)
Well, that didn't surprise me at all. Not that I could predict whether or not this was going to happen with any one drug, because it's really hard to predict, and we have machine learning models to do that, but even so, you can't predict perfectly. No, I think that this is exactly the motivation for the business model that Bridge Bio undertook. The fact is that investing in biomedicine has this really peculiar property that doesn't exist in most other industries. And that's the binary nature of these FDA clinical trials. Either the drug succeeds or it fails. If it succeeds, all investors will make a ton of money. If it fails, you lose literally everything. It's worth zero.

35:00
Dr. Andrew Lo (Guest)
This kind of feast or famine situation is why you see with many biotech and even pharma companies, huge run ups in stock prices when a clinical trial works out, and huge crashes when a clinical trial doesn't. For typical investors, this roller coaster ride is not acceptable. And so in a portfolio approach, you actually will see a much more muted kind of return profile. And depending on how large the portfolio is, even with the portfolio of ten or 20 assets, we still had these big ups and downs. But if we only had one asset, there wouldn't be big ups and downs, there would just be one big down and that would be the end of the story. You won't live to see another day.

35:49
Dr. Andrew Lo (Guest)
But because of the diversification and the kind of financing that we had, even though the stock price did get hit pretty hard, we actually were able to live to see a day where that very same drug that didn't do as well in that original phase Three trial. In the longer version of that Phase Three trial, just with 18 more months of data, that drug has actually ended up doing really well. And it's likely to become a blockbuster if it gets approved. And based upon the results of that Phase Three trial, it looks like the ODS are pretty good. So that's an example where the financing can help you live through the roller coaster ride of these ups and downs.

36:28
Neil Littman (Host)
Andrew, there have been other companies that have emerged with a similar approach. Is there anything that you've seen that can distinguish those companies that have used this approach successfully from others who have maybe not used it quite as successfully?

36:44
Dr. Andrew Lo (Guest)
Well, there's a lot of randomness in drug development to start with, so I think we all have to acknowledge that although there are many people out there that have very talented abilities to select good drug projects, the bottom line is even the most talented folks aren't going to be right more than, I don't know, pick a number. 60% of the time. And that means that 40% of the time you're failing. And so with any portfolio, there's always the risk that all of your bets go south. That risk is generally lower for a portfolio than it is for a single asset company, but there's no guarantees in this space. So I think that the execution of this portfolio approach depends on a couple of things.

37:29
Dr. Andrew Lo (Guest)
One, it depends on how good your portfolio modeling is, and you have to understand how to construct that portfolio with an eye towards minimizing your correlations. And the second, of course, is to be able to pick very good projects and do your best, even though it's not possible to pick winners for sure, to do your best, to do the science and medicine properly so that you are giving yourself the very best possible chance of success. And that applies not just to healthcare, but really any field, whether it's software or manufacturing or energy. It's really the creativity of the entrepreneurs that are giving you the multiple shots on goal to use a soccer or a hockey term. And then, of course, being able to come up with the appropriate financing structure to be able to make that multiple shots on goal likely to succeed.

38:20
Neil Littman (Host)
Andrew, I'd like to pivot a little bit and ask you about a different area of health where you are working to create new models. This is on the payment side for expensive medicines like cell and gene therapies. What is the challenge, particularly in our healthcare system here in the US. To get payers to recognize the value of these new therapies. And what does that mean to the sustainability of these emerging medicines?

38:48
Dr. Andrew Lo (Guest)
Well, those are really important issues that I first became aware of when I read the headlines of the drug Solvaldi. This is a drug that was approved maybe ten years ago to treat hepatitis C. It's a drug that was put forward by Gilead, and it's a cure. You take pills for eight to twelve weeks, and at the end of that process, you are cured of hepatitis C. And I thought, wow, this is an amazing breakthrough. The cost of that treatment is about $84,000 list. And so when that came on the market, I thought, what a bargain. Because if you think about the cost of dealing with a hepatitis C patient, first of all, you have to treat them anyway. And so it's not as if $84,000 is a particular big cost. You have to ask what the relative cost is.

39:46
Dr. Andrew Lo (Guest)
And it turns out that for a Hep C patient that ultimately suffers enough liver damage, they're going to have to undergo a liver transplant. And the cost of a liver transplant, at least back in 2010 when I was looking at these numbers, is about $900,000. So to me, $84,000 versus $900,000. What a bargain. And so I was kind of shocked when the CEO of Gilead was dragged before a Senate committee and really just pilloried for being such a greedy capitalist pig. And I didn't understand it because I thought that the CEO and all of the members of Gilead's scientific development team should be thanked by the rest of us for providing a cure to this terrible affliction.

40:39
Dr. Andrew Lo (Guest)
And as I read more about the situation, I realized that what the problem was not the cost of the drug, because $84,000 from any pharmacoeconomic analysis is a bargain relative to what you're getting in exchange, you're getting a healthy life. And what the problem was is that $84,000 is a one time payment for the cure. And at the time, I think there were maybe two or 3 million Hep C patients in the US. If you had to pay $84,000 for all of them in the same year, that would pretty much wipe out a lot of the health plans that are self insured. And even Medicare, Medicaid would have a hard time swallowing that kind of lump sum payment. So to me, the problem was not is the drug a good drug and is it worthwhile?

41:32
Dr. Andrew Lo (Guest)
Clearly it was a bargain even at the list price of 84. And most payers don't pay list price. But the problem was instead, can you afford the payment upfront because it is a big one time hit, and because it is a cure, you're only paying once. And immediately that brought to mind the difference between renting an apartment and buying a house. Most of us can't afford to buy a house right out of school. We have to work for a number of years, save up some money, and then at some point, we have enough to buy a house. But the amount that we save is not the cost of the house. If were forced to purchase a house in cash, even fewer of us would ever be able to afford to buy a house. No.

42:21
Dr. Andrew Lo (Guest)
Instead, what happens is that we recognize that a home has years and years of housing services. And so instead of paying for it up front, why not spread out the payments over the useful life of a house? And so that's when the idea of a 30 year mortgage emerged. We can buy a house simply by borrowing money from a bank and then spreading out the payments over 30 years. Why can't we do that with drugs? And so the idea of creating a drug mortgage market occurred to me, and that seemed to be a useful way of making these one time cures more affordable. So I wrote a paper, published it in 2015 with collaborators like David Weinstock, who's a well known cancer doctor and knows a great deal about these issues. We published a paper in 2015 titled buying Cures versus Renting Health.

43:26
Dr. Andrew Lo (Guest)
And that's really, in a nutshell, the idea that were working on, which is instead of expecting people to buy a cure upfront with whether it's $84,000 or in the case of gene or cell therapies, we're talking two or $3 million to cure a disease, instead of expecting people to pay upfront, why not spread out that payment over time? And so that was the original idea, the drug mortgage. But it became clear very quickly that wasn't really practical because, well, people leave one health plan and go to another. And so if you have one health plan taking out a mortgage to help pay for one of their members, and they provide the treatment, the member is cured, but the insurance company has to pay the mortgage for 30 years or however long.

44:17
Dr. Andrew Lo (Guest)
And it turns out that healthy patient, once cured, leaves the healthcare plan to go to another let's say you move to another state, you move to another healthcare plan. That means that the other healthcare plan is going to be getting the benefits of that healthy patient. But the original healthcare plan that is still paying the mortgage is left holding that mortgage without the premiums from that healthy member. So clearly, that isn't going to work unless you're able to take that mortgage payment and force the new health care plan to take it on. But given that we're not going to be able to change the Affordable Care Act anytime soon, I started talking to others about creating a different approach and finally settled on this idea of a subscription model, also called the Netflix model.

45:05
Dr. Andrew Lo (Guest)
And the idea behind that is to basically reinsure healthcare plans. And the idea behind the subscription model is to have all of the various different members of a given healthcare plan pay a small subscription fee to the lowest cost provider of that kind of therapeutic. And, of course, who is the lowest cost provider? It's the drug manufacturer itself. So the idea is to have a reinsurance program where the healthcare plan subscribes to a particular drug developer's gene therapy. And then the gene therapy is provided to any member that has that subscription at no additional cost. So basically, it spreads out the cost of therapy to a larger audience, and that reduces the cost to the system.

46:01
Neil Littman (Host)
Andrew, through Quantile Health, you've taken this from the abstract to the real world. I'm curious what your discussion has been like with Payers and with drug and pharmaceutical companies. What's their response been like?

46:17
Dr. Andrew Lo (Guest)
Well, initially there was some skepticism because they didn't quite understand how this model worked. And I don't blame them because it is a rather unusual approach. I guess the best way to understand it is to first try to get a sense of how these very expensive therapies are being covered today. So take a drug like Zolgensma. It's a gene therapy that cures patients with a disease called spinal muscular atrophy. This is a terrible affliction that causes paralysis and other problems and complications. And the life expectancy of SMA patients is in the single digits. So right now, how would a patient get treated for this very expensive therapy? Well, imagine there's a company that's got about 1000 employees.

47:07
Dr. Andrew Lo (Guest)
This is a typical self insured plan where, because they've got so many employees, instead of getting another insurance provider, they will just set aside a certain amount of money to pay for their own employees needs. So with 1000 people, typically, the healthcare budget is around $6 million a year. And that's what the company has to set aside to pay for its health expenses for its employees. If there is a single patient that has SMA and that needs this treatment, that's going to cost this health plan $2.1 million, that's the list price that Novartis is charging for this particular therapy. And what that means is that a third of that health plan's budget is wiped out with just one patient. And that's a real problem. So that's the kind of risk that the health plan is unlikely to be able to take on.

48:00
Dr. Andrew Lo (Guest)
So what they'll do is they'll try to get rid of that risk by engaging in something called reinsurance. The way reinsurance works is you get a company like Genreee or Swiss Re or Munich Re, and they will agree to cover the cost of any SMA patients in the employer's population in exchange for payment of certain annual premium, the reinsurance cost. Now, this works, but the problem is, today the cost of reinsurance is really high, something on the order of 800% of the actuarial, fair value of the policy. And so many health plans, particularly those smaller companies that are self insured, they can't afford this. And even the ones that can, they get into this really frustrating dynamic where they may have a patient that needs to be treated. So the employer will contact the reinsurer and say, hey, we've got a patient.

49:01
Dr. Andrew Lo (Guest)
We need $2.1 million. And the reinsurer will push back and say, you know what? Maybe you don't need to treat it right now. Maybe you can let the patient wait a year or two and then we'll pay for it. So you get this really frustrating dynamic where the reinsurer will either refuse or delay coverage. That's the current status quo. Now, where Quantile comes in is to say, let's create a different payment model. The payment model is instead of having the employer pay for reinsurance to this really expensive provider. And by the way, the reason that it's so expensive is not just because of greed. It's really because of the structural restrictions insurance markets. If you're providing reinsurance, then regulators will require you to maintain a certain amount of capital. You called reserves.

49:57
Dr. Andrew Lo (Guest)
And so you have to charge an extra premium because those reserves are sitting around and not earning a lot of interest. And so, because of structural reasons, it's hard for reinsurers to charge much less than what they're charging now. But the idea behind a subscription model is instead of using a reinsurer, you would approach the cheapest cost of reinsurance. And who is the low cost provider? It turns out the low cost provider is the drug manufacturer itself. So in this ideal scenario, the independently self insured employer will approach Novartis and say, novartis, how about if we pay you a certain subscription fee?

50:44
Dr. Andrew Lo (Guest)
I don't know, let's say fifty cents per member per month, and we'll pay you that right now across all of our members in exchange for the agreement that if we have an SMA patient in our population, you, Novartis, will agree to provide the gene therapy at no additional cost above and beyond the subscription fee. And Novartis is the low cost provider because they invented the drug. And anybody else that's going to be providing that kind of reinsurance is going to have to buy the drug from Novartis. So they're the cheapest cost provider, and they're happy to do so because what they're getting in exchange is the actuarial fair value plus a markup of, I don't know, 15 or 20%, and they're getting steady cash flows from day one.

51:34
Dr. Andrew Lo (Guest)
So rather than waiting for individual patients to be treated and getting these lumpy $2.1 million checks and getting into these fights between reinsurer and employer, where they're going to refuse or delay coverage, now what they're getting is a subscription model where they're getting cash flows right away. So this is the business model that Quantile Health is developing. And so far, we're getting some really good traction. There are a number of biotech companies that have signed letters of intent to agree to use our platform, and we're in discussions with a number of payers now who also want to be part of this plan and be the subscribers. So we plan to launch a pilot sometime in early 2020.

52:17
Neil Littman (Host)
I love the model and the creativity. Andrew, what do you think it will take for this model to ultimately be successful at scale?

52:28
Dr. Andrew Lo (Guest)
I think what it will take is a gene therapy that is going to hit the market like a storm and then make it impossible to use any other payment model. So right now, gene therapies that exist are for relatively rare conditions, and so it's not really affecting payers other than the smaller payers that I just described. It's not affecting the big payers a whole lot because frankly, there's not that many patients that need to be treated. But we're probably six to twelve months away from an FDA approval for a drug to treat sickle cell disease, and that is not nearly as rare. There are probably 100,000 patients that have sickle cell in the United States right now, and more every year that we are learning about.

53:17
Dr. Andrew Lo (Guest)
So when we have an approved gene therapy for a less rare condition, that's when this payment model is going to become necessary because there's no other way to afford it. We're going to see a similar kind of problem that we saw with Solvaldi and Harvoni when they hit the market and these one time cures and they apply it across lots of patients, that's going to create enormous amounts of financial stress to the system. And this payment model that we're proposing is really meant to reduce that stress. And that's just for these rare conditions. There are over 200 gene therapies in late stage clinical trials, and some of them are actually targeting very common diseases like macular degeneration or heart disease. So can you imagine if we get a gene therapy approved and it's $2 million to treat high cholesterol?

54:08
Dr. Andrew Lo (Guest)
That's going to be an extraordinary hit to the system. Even though it's a tremendous boon to patients, we're going to need a better payment model to deal with that. And I think at that point, the subscription model will become much more popular.

54:21
Neil Littman (Host)
Yeah, it makes a lot of sense. I mean, the last thing that we want as a society is constraints around the payment system, holding back novel therapies that are helping patients. So I certainly applaud your efforts on this front. Andrew, I want to be cognizant of your time. I could literally spend the next week talking to you about all of these different topics. I want to just end with one last question for you, and that is any advice for young entrepreneurs out there who are perhaps looking to build the next bridge bio?

54:52
Dr. Andrew Lo (Guest)
Well, first, I should acknowledge that I am no biomedical expert by any means, so it would be a bit arrogant for me to be giving advice to biotech entrepreneurs. Although that hasn't stopped many economists from giving advice of all sorts. But I guess I would make a few observations perhaps, and that is that sometimes the way that things have been done is not necessarily the way things ought to be done. And keeping an open mind about alternatives for creating new businesses is both important and profitable, because not all everybody because not everyone has the answers all the time. And so having a healthy degree of skepticism on the appropriate business models that are being used to deploy capital for biomedicine is a really interesting area, particularly because I think that finance and medicine need to go hand in hand.

55:59
Dr. Andrew Lo (Guest)
You really have to work together in a collaborative fashion to be able to come up the right financing for the right drug development project. I make very clear to my MBA students when I teach healthcare finance that finance definitely should take a backseat to the science and medicine of drug development, because better financing can't turn a bad drug into a good drug. But the wrong kind of financing can definitely take a good drug and destroy it and make sure it never reaches patients. So the science and medicine and so the science and medicine should come first, but soon thereafter, we ought to be thinking about the appropriate kinds of financing that is going to be able to support the science and medicine.

56:48
Dr. Andrew Lo (Guest)
And if we do that, I think there are all sorts of new companies that we can build to help patients with unmet needs.

56:54
Neil Littman (Host)
I could not agree more, Andrew. Well, with that, I'd like to say a big thank you for joining me on the show today and for your time.

57:03
Dr. Andrew Lo (Guest)
Thanks so much. It's been a pleasure and a privilege to be here.

57:08
Danny Levine (Co-host)
Bonnie, what did you think?

57:10
Neil Littman (Host)
I thought that was a really fantastic discussion with Andrew. I mean, we hit upon all these points that I really love to talk about, and you heard about a lot of his pioneering work, and I love the story that he shared about Harvey Lotus. I think it's just such an inspirational story. And he's exactly right. A lot of folks don't have a PhD in the biological sciences are never going to create medicines themselves. But that doesn't mean that all of us can't invest in these types of novel biomedical innovations that could potentially help our grandchildren one day, as was the case with Harvey. And so you just never know. And I really applaud Andrew's creative financing structures and how they have been applied to biomedical innovation. And I really love what Bridge Bio has done. I love the cancer mega fund concept. Right?

58:03
Neil Littman (Host)
And so he sort of reduced the problem from being a scientific problem only to being one of more of a financial problem. And the financial problem is solvable. And Andrew has come up with a variety of different creative approaches to solve the financial problem. Obviously, you can't predict the science, but there are ways to spread the risk around to make it an attractive way to invest in all these innovations from a risk adjusted return profile. So I thought Andrew gave a bunch of great examples there. So I thought it was a really fun conversation.

58:38
Danny Levine (Co-host)
One of the interesting things he talked about was managing correlations. It was actually a good argument for using this approach to rare diseases firm. My guess is that a lot of investors pride themselves on deep knowledge and commitments to narrow areas. Do you think investors think about the importance of managing correlations in terms of managing risk?

59:01
Neil Littman (Host)
I think it's a really good question, Danny. I can't speak for all investors. I can speak from my own personal investment philosophy and standpoint, and we certainly do. And that's largely based on the work that Andrew has done, has had a major influence on how I think about constructing the portfolio at Bioverge. And so for us, we think about uncorrelated assets being in different modalities, so maybe a cell therapy, a gene therapy, a small molecule biologic or going after different therapeutic areas or indications. So not just oncology, but oncology and neurodegenerative diseases and then different indications within all of those to build a nice portfolio that we feel like gives our LPs and us a nice risk adjusted return profile of largely uncorrelated assets. Now, they're not all uncorrelated. There's absolutely some amount of correlation between all these.

59:56
Neil Littman (Host)
But I think you heard Andrew's point around Bridge Bio in particular and why rare diseases were such an attractive target is because they are all very different and so they all are very uncorrelated from each other, although maybe some of them are using the same type of therapeutic modality, right? So there's probably some amount of correlation even within the Bridge Bio portfolio. But I don't know, I don't think that too many investors probably think about the uncorrelated aspect of the portfolio when they're constructing a diversified portfolio.

01:00:33
Danny Levine (Co-host)
We've long had companies boast about having multiple shots on goal. In reality, we're seeing a lot of companies paring down their pipelines today and being very milestone dependent on getting to the next financing. There's a business model that Andrew's arguing for. But is there any way for a traditional biotech to learn from the portfolio approach in today's environment?

01:00:55
Neil Littman (Host)
Well, that's a really good question, Danny. I mean the paring down of pipeline is a direct result of the financial and economic environment that we find ourselves in. Access to capital is very difficult these days. And so investors are demanding a real paring down of assets, a real focus on a lead asset, or maybe two, really pushing to get data, compelling data around that lead asset, right, getting the proof of concept. And so it's the economic reality that we live in. And so I don't know a way to sort of bridge those two. I think it's difficult.

01:01:31
Neil Littman (Host)
I mean, oftentimes companies need to push really hard on a lead asset, get proof of concept for whatever it is they're doing, maybe their platform technology, and then use that as a piece of leverage to raise additional capital to build out the rest of their portfolio. And so we're seeing more of that type of approach. And maybe that's one way to solve the problem, but certainly by no means the only way to solve the problem.

01:01:52
Danny Levine (Co-host)
The price of advanced therapies are a growing concern, particularly as there's a large pipeline of therapies that are approaching market. And you talked about the Netflix model, a subscription arrangement to pay for these therapies. What did you make of that?

01:02:07
Neil Littman (Host)
I love the idea. I mean, there's no question that a lot of these novel therapies have high price tags. You heard him talk about the case of Cervaldi, which had an $84,000 price tag for a curative based therapy for Hep C, and there was this huge backlash from the public and from Congressmen, and you're thinking, wow, this is a game changer for these patients. It's actually saving the healthcare system a tremendous amount of money because you heard them reference the 900,000 plus dollars price tag for a liver transplant. But yet there's this huge backlash. And so I think as you think about applying this type of model, it becomes number one. It could be a public relations win because you don't have that high upfront cost and that immediate sort of backlash.

01:02:55
Neil Littman (Host)
But it also is a much more financially viable approach for these types of high priced therapies, particularly as you move away from orphan and rare diseases, which only have 100 or a couple of thousand patients, to large patient populations like diabetes or cardiovascular disease or neurodegenerative diseases, for example, that have many thousands or hundreds of thousands of patients. And so I think Andrew rightly pointed out these types of subscription models are emerging now. We're not forced to use them yet, but probably in the not too distant future, there will be a forcing function to adopt these, because the price of these therapies will be too high to sustain over large patient populations.

01:03:41
Danny Levine (Co-host)
Well, until next time.

01:03:43
Neil Littman (Host)
All righty. Thank you, Danny.

01:03:47
Danny Levine (Co-host)
Thanks for listening. The Bioverge podcast is a product of Bioverge, Inc. An investment platform that funds visionary entrepreneurs with the aim of transforming healthcare. Bioverge provides access and enables everyone to invest in highly vetted healthcare startups on the cutting edge of innovation, from family offices and registered investment advisors to accredited and nonaccredited individuals. To learn more, go to bioverge.com. This podcast is produced for Bioverge by the Levine Media Group. Music for this podcast is provided courtesy of the Joan Levine Collective. All opinions expressed in this podcast by participants are solely their opinions do not reflect the opinion of Bioverge, Inc. Or its affiliates. The participants'opinions are based upon information they consider reliable, but neither Bioverge or its affiliates warrant its completeness or accuracy, and it should not be relied on. Nothing contained in accompanying this.

01:04:49
Danny Levine (Co-host)
Podcast shall be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to purchase any security by Bioverge, its portfolio companies or any third party of past performance is not indicative of future results.