Economist, finance professor and investment manager Andrew
Lo says some of the financial weapons of mass
destruction that helped trigger the 200809
crisis can be used for good. If deployed in megafunds by teams
of savvy money managers and scientists, he believes, the
securitization of intellectual property related to biomedical
research could yield lucrative returns while also breathing
life into what the biotechnology industry calls the valley of
death neglected early-stage, risky drug development
projects for the rarest and most intractable diseases.
But Lo, who has conducted several simulations that he says
show this strategy could work, is just the idea guy.
Im not qualified to manage any of these
vehicles, explains the director of the Laboratory for
Financial Engineering at the Massachusetts Institute of
Technologys Sloan School of Management. Im
hoping to play the role of glorified wedding planner. Ill
bring the bride and groom together; they should know what to do
after the wedding.
Lo, who holds a BA and a Ph.D. in economics from Yale
University and Harvard University, respectively, didnt
tackle this problem only out of academic curiosity. He began
his investigation after watching several friends and his
mother, who lost her battle with lung cancer in 2011, go
A very strange contradiction emerged: Scientists and
clinicians are making breakthroughs all the time with regard to
drug developments, but the amount of funding that is going into
biomedicine is declining, says Lo, 55, adding, It
seems to be the worst possible time to be pulling money out of
Lo first proposed the idea of creating a megafund in 2012,
co-authored a paper in the journal Nature
Biotechnology arguing for the securitization of
intellectual property related to biotech research as an
incentive for investment.
The U.S. governments funding of medical research has
been trending downward since 2004,
according to a study published this past January in the
Journal of the American Medical Association. The money
that is committed tends to be channeled toward diseases that
affect large numbers of patients. The private sector
hasnt picked up much of the slack because such projects
are expensive, time-consuming and risky.
But if investors can be convinced of well-diversified risk
and sufficient returns, Lo believes theyll take a chance
on innovative new treatments for diseases like cancer and
Alzheimers as well as so-called orphan diseases that
each affect fewer than 200,000 people in the U.S., such as
Tourette syndrome and amyotrophic lateral sclerosis (Lou
In the simulation at the heart of their 2012 paper, Lo and
his colleagues used data from the Boston-based Tufts Center for
the Study of Drug Development to create a mock oncology
megafund. They looked at several different sizes of fund, each
time splitting it into two tranches of debt senior and
junior and an equity tranche. Based on hypothetical
performance from 1990 to 2011, on average the junior slice
would have yielded a return of 8 percent; the senior, 5
percent; and the equity tranche, up to 11 percent.
I was surprised to learn that the numbers we were
getting were pretty reasonable and in conformance with
venture capital industry norms, Lo recalls: Default rates
were very much in line with what youd expect those yields
to be associated with.
Lo says many institutional investors might be attracted to a
real-life version of such a fund, which he and his colleagues
tested at sizes ranging from $5 billion to $15 billion.
Thats a lot of money to raise, but with enough
diversification it should be justified, he contends.
More projects equal lower risk, Lo says,
emphasizing that not every project or drug in a megafunds
portfolio must be successful for investors to cash in.
Were just trying to have a few big
One question that remains is how to value portfolio
investments, especially given the uncertainty surrounding the
development of new drugs. Lo, who is known for his work in
determining what caused the most recent financial crisis,
mortgage-backed securities cousins of the
research-backed obligations hes now proposing were
valued far too optimistically, and that RBOs could suffer the
Portfolios of these illiquid assets were not marked to
market but rather marked to model, or marked to fantasy, as one
trader put it, he says of MBSs. Valuations [in
megafunds] need to be based on market discipline; otherwise
investors can misestimate both their risk and reward, causing
them to overinvest or engage in panic selling.
Lo recommends that those who create megafunds and the people
they choose to manage them he suggests former
pharmaceuticals executives, life sciences hedge fund managers
or biotech venture capitalists should have their
portfolios regularly valued by third parties, as is now common
practice for mortgage portfolios.
Investors may soon be able to see a disease research
megafund in action. In February, Lo and his colleagues published
another simulation, using data from the National Institutes
of Health in Bethesda, Maryland which conducts more
medical research than any other group worldwide and
found that a fund concentrating on its 28 rare-disease projects
could achieve average annualized returns of between 12 and 15
percent over 11 years.
Some investors actually contacted the NIH and said
they would be happy to invest if they could get some kind of
public-private partnership structure, says Lo.
Thats not currently legal, but on October 9,
Democratic Representative Juan Vargas of California and his
Republican counterpart, Thomas Rooney of Florida, introduced a
bill that would allow the NIH to create a megafund. This
vehicle would be privately owned and operated and would invest
in early-stage therapies for rare diseases. In addition to
advising the fund, which would operate as a public-private
partnership, the NIH would be able to sell it intellectual
property in exchange for an equity stake in its portfolio
The simple truth is that in biotech and life sciences,
traditional financing vehicles of private and public equity are
becoming less effective, Vargas says. The life
sciences industry needs novel approaches to early-stage
The megafund model presents this opportunity, according to
Vargas. My legislation merely allows the validity of this
approach to be demonstrated by authorizing a pilot
program, he says.
The idea has global appeal: In June, London Mayor Boris
Johnson, with whom Lo has discussed his research, suggested
that banks, investors and drug companies such as AstraZeneca
and GlaxoSmithKline join forces to create a £10 billion
($15 billion) megafund to compete with the U.S.
Robert Langer, a professor of chemical and biological
engineering at MIT who has more than 1,000 pharmaceutical,
chemical and biotech patents under his belt, is a vocal
supporter of Lo. Langer believes the implementation of such
megafunds could allow the new drug delivery systems and
regenerative medicine techniques that he invents to move from
the pages of science papers to the real world.
I like the idea very much of using financial things
for good, Langer says. If hes successful,
this will be an out-of-the-box way of thinking about raising
funding for research.