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Impact funds and innovations in the health sector

With public health systems under strain from reductions in public spending and ageing populations, we discuss how private investors should explore the commercial opportunity presented by health funds.

By David Gowenlock, ClearlySo Funds Advisory and Carl Bergholtz, Healthcare & Well-being Investment Manager · May 10, 2020


Constituting a significant portion of most economies, health spending currently totals c.10% of global GDP and is projected to rise at a CAGR of 5% from 2019-23, up from 2.7% over 2014-18.

What at first seems an interesting growth opportunity becomes much more complex when diving deeper. For example, spending on a per-capita basis is very unevenly spread, with 2023 forecasts ranging from c.US$12,000 in the United States to just c.US$45 in Pakistan. Furthermore, efforts to close this gap will be hampered by the higher population growth expected in many developing economies.

Healthcare needs vary significantly in different regions of the world. As countries develop, the main causes of death shifts from being related to infectious diseases to chronic, long term conditions. In fact, many of the top 10 causes of deaths globally in recent years are related to unhealthy behaviours.

Source: ‘2020 Global Health Care Outlook’, Deloitte

Along with the growing recognition of individual choices in one’s health, we are thankfully also seeing greater awareness of mental health issues and the impact they have on peoples lives. One in four people worldwide will be affected by a mental or neurological disorder at some point in their lives placing such conditions among the leading causes of ill health and disability. With the World Health Organization now naming mental health care a fundamental right, it becomes all the more important for the global health community to identify ways to improve mental health outcomes. Disruptive technologies can play a vital role in combating these often-debilitating conditions and hold great promise in the delivery of mental health interventions.

At the same time the interconnectivity of health and other factors such as food, nutrition and agriculture are becoming increasingly apparent. This is demonstrated by various alarming statistics, such as the projection that deaths resulting from antibiotic resistance will surpass that of cancer by 2050, with a leading contributing factor being the vast quantities of antibiotics used in animal agriculture—and the resulting growth in resistance to antibiotics. Our health systems were faced with the these issues before we even entered the current pandemic – a situation which is straining our health systems and the people who work in them to the absolute limit.

Aging populations and austerity

As a result of these factors more and more stakeholders are calling for a reform of the way we consider and design our health systems away from a system of sick care – treating patients after they fall ill, to one of health care – supporting physical and mental well-being, prevention, and early intervention.

Public health commissioners are facing a perfect storm of challenges; reduced budgets due to the recent period of austerity, the rise of long-term chronic conditions, aging populations and increasing labour costs as healthcare workers are recruited into the more lucrative private sector.

This combination is putting a huge strain on healthcare providers worldwide:

  • UK: 47% of NHS trusts—which provide secondary care to patients who’ve been referred there by a GP—were in the red in 2018/19. The figure was 67% just among acute hospital trusts—which make up the bulk of NHS trusts across England.
  • The Netherlands: The average profit margin in 2017 for clinical hospitals in the Netherlands was only 1.8%, resulting in approximately half of them needing major cost transformations.
  • Germany: 12% of German hospitals are in financial distress and the numbers of insolvency cases are growing
  • US: The margin of a typical US health care provider is only 3%, yet actuarial analyses and market trends predict margin degradations of 6% by 2023
  • China: Medical insurance funds’ expenditure growth exceeded growth in revenue in 2018, burdened by the country’s slowing economy and aging population.

Can private capital provide part of the solution?

Despite the need for change, health systems are restricted by tight regulation, legacy technology and often slow processes, causing them to struggle to keep up with the latest innovations emerging from the health sector’s start-up community.

There is no doubt that technology can help increase efficiency and reduce the cost of delivering care. This raises the critical question of the potential role for private capital to help fund these innovations and in turn address some of these challenges.  How should investors evaluate the resulting opportunities in the health sector? To discuss these questions, ClearlySo recently spoke with three diverse private market investors to explore these issues. Their insights are instructive in shining a light on this important yet complex sector.

Wellington Partners is an experienced European investor focussed on life sciences (therapeutics, medical devices, digital health and diagnostics) and currently investing out of the firm’s fifth fund.

The team suggests that some of the key reasons LPs should consider life sciences funds as part of their allocations are the low correlation and differing risk profile to other market sectors, the fact that the healthcare sector is stably and steadily growing, largely recession resistant and has lesser or delayed impact from the broad macroeconomic situation. Hence, this sector presents an opportunity for diversification, and with appropriate fund selection an opportunity for alpha. We spoke with Dr. Karl Nägler, Managing Partner to hear his insights:

Why should LPs invest in this sector?

Over the last 5-10 years there has been significant interest in the healthcare space and in life sciences and digital health in particular – the interest and investment performance is due to market entries of novel products, largely fuelled by decades of biomedical research produced by young companies in the biopharma, med-tech to digital health space. Many of those products have not just been commercially successful, but also transformative in the way they treat diseases or improve healthcare delivery, demonstrating how innovation can help to address the challenges posed by the societal trends of aging populations and associated rise in chronic diseases while also responding to healthcare-cost containment and digital consumerism.

These successes seen have not been one offs – more and more experienced serial entrepreneurs are now developing products and often with close ties to pharma/med-tech corporates, both of which has professionalized the sector, while it has not lost its dynamism.

We expect superior performance to last, even though some segments are overinvested and selecting the right opportunity remains very important.

What is the firm’s investment thesis?

Whilst the life science sector has seen significant progress recently, there are also challenges around such as market access/reimbursement or accurate identification of which patient group would benefit from certain treatments. The firm believes that it is therefore not sufficient to just back new biology, science and interesting novel approaches, without also considering how to develop those and what the path is to reach a commercially successful product addressing real medical needs. Our team is therefore comprised of colleagues with a broad range of backgrounds – from biologists to medics. Having professional experience of treating patients is critical to understanding care pathways and the delivery of health innovations.

This strategy also leads to broader view of what innovation means. Many other funds have narrowed their focus to therapeutics following headline grabbing exits and IPOs. Us too, deploy a large part of our capital into therapeutics, but our investment team has been in this field long enough to know there are cycles within this sector too and we have continued to invest into other segments such as medical devices, diagnostics and digital health.

What are the keys risks with this strategy?

A common issue for therapeutics and medical devices is operating in a very ethical and highly regulated environment – many boxes need to be ticked for a product to become successful and a “minor” issue can make the whole company stumble. As an example, a company may have great tech, robust product proposition and business model, sound data, yet cannot manufacture their product without an impurity that regulators view as a risk and/or that might put patients in danger. This fact demands that investors’ due diligence process must be at highest standards as well as the monitoring of the portfolio monitoring and the governance within the investee companies, increasingly applying and promoting ESG principles.

Investors in this field typically aim to take projects to a point where they have answered some of the problems and questions, a point at which a strategic acquirer such as pharma or med-tech corporate can continue product development. Exits via IPOs are also possible, but are dependent on the status of the capital markets and often require further development towards a more mature stage. We therefore believe it is key elucidate the interests of corporates from the start.

In our view in order to build a successful portfolio it is important to have expertise around how to develop and de-risk opportunities with the aim to enhance their strategic value, not seeking to take on the risk of a full development cycle in each investment case. It is important to be somewhat diversified, steady and not led too much by momentum – both in terms of money flows and recent high profile exits.

What do you feel is the impact of COVID-19?

COVID-19 has had a big impact on some areas – for example putting a big strain on therapeutic product development since many ongoing clinical trials have been stopped and it is currently extremely hard to start new ones. This may have a significant impact on product development and approval timelines.

On the other hand, we see opportunities (including in our portfolio) e.g. for companies developing diagnostics, vaccines or treatments for COVID-19:

Our portfolio company Themis Bioscience is one of the frontrunners in the quest for a COVID-19 vaccine that is not just safe and efficacious, but where a global supply appears feasible within a relevant time-frame. Quanta Dialysis Technologies is developing a versatile next generation (home) haemodialysis system, which it is has started to deliver to hospitals in the UK, since half of COVID-19 patients treated in ICUs are requiring transient haemodialysis.

Lastly, with our most recent investment into SIRS Therapeutics we supported a product candidate (FX06) that had in the past shown efficacy trends in related indications and might accelerate the course towards normal lung function in hospitalised COVID-19 patients.

Luminous Ventures invests in applied science and breakthrough technology in human health across healthcare, life science, food, nutrition and agriculture. The firm is currently investing out of its first fund and is raising its second fund.

Max Ward, Luminous Ventures’ Co-Founder proposes this is an exciting area for LPs to be investing; it constitutes a large portion of the economy (nearly 20% of US GDP), is robust to economic cycles yet presents potential for significant upside. In addition, it is a very conservative area and therefore ripe for new technologies which can drive significant change within that system. Significant changes may be needed to upgrade healthcare systems to increase patient outcomes and decrease costs – and the application of technology is a key component of that.

What is the firm’s investment thesis?

Luminous Ventures focuses on the following areas:

Healthcare – digital products for diagnosing and treating patients, as opposed to mere “healthcare IT” and care coordination. There is significant scope for digital platforms to drive value in these areas – they give clinicians scale, helping address staff shortages, are cheaper and are superior in terms of data collection.

Life science – There is a huge wave of automation needed to cut costs and increase efficiency in life science, particularly in the area of drug discovery where costs are doubling every seven years. Automation technologies can add significant value here.

Food and nutrition – As the global population increases and becomes wealthier, there will be a wave of compelling innovations in areas necessary to tackle food security, safety, public health, environmental concerns and animal welfare.

The next wave of top tier venture returns will be derived from the commercial application of the new platform technologies such as AI, robotics, quantum computing, mixed reality computing and edge computing. In the same way the adoption of the internet drove value across sectors, these platform technologies will do so in next 10 years. These technologies have huge applications in the health, life science and food industry to increase quality of care and decrease costs.

Within the VC ecosystem many companies were leveraging existing technologies, creating a saturated market where it was hard for funds to derive top-tier returns. To provide attractive returns investors must look to deep technologies that can really unlock value by deriving significant change within businesses.  We are moving into the automation and augmentation era, beyond mere connectivity (internet) and data collection and analysis (big data).

Whilst the UK and Europe has strong access to talent and research, the region has perhaps underperformed in commercialising it. As is common in VC the key is finding high performance teams – differentiated technology is important, however the team is more important. One key factor in healthcare is distribution, a key part of treatment delivery that is very complex; founders with this knowledge and experience is key. Another is clinical efficacy which is critical to secure credibility with doctors and insurers – very robust and strong data showing efficacy is key since important stakeholders seek outcomes, and will only engage with and ultimately pay for novel solutions if these outcomes can be demonstrated.

What are the keys risks with this strategy?

Health innovations take a long time to reach the market, there are layers of risk and the regulatory risk on top of the conservative nature of the industry makes the market slow to adopt new innovations.

Luminous Ventures does not generally invest in consumer healthcare solutions since, whilst there has been some success stories in this area, most of the companies are just marketing operations without any underlying new IP.  The most interesting area here is on the data side – for example, see the 23andMe deal with Glaxo.

Demand is constantly rising due to growing and aging populations. Off the back of COVID-19 we expect demand will grow further due to need of greater efficiency in our health care systems from hugely increasing costs.  There is also a big move to value-based healthcare – it’s not just about delivering a service, you need to show how much value you have added – technology will be important in this.

How do you compare yourselves to other similar firms?

Luminous Ventures differentiates ourselves by being as value-add and founder friendly as possible. We lead 75% of our deals, work really hard for the founders, and as a result reference very well. Many VCs say this but not all actually do it.  This allows us to get into any deal we want, which is key in VC where you only want to be investing in competitive deals. So far we have lost only one deal based on another investor at a higher valuation. We have a very strong reputation among founders and thus achieve greater deal access. In this stage of VC you don’t make returns based on negotiations of the deal terms, you make them from getting into the right deals. Terms should be in the right ballpark, however as a seed investor you should be much more concerned about getting in the right deals.

There are more and more generalist VCs moving into healthcare now but they will struggle to get into the best deals because they don’t have the right reputation and they also don’t know how to build companies in this space. As an example many will view revenue as the key KPI and will push start-ups towards revenue too early at the expense of something else (for example, data or R&D).  This can be very dangerous in healthcare.  Auris Health (a technology company and not a therapeutic one) was bought by J&J for $3.4 billion (with milestones up to $5 billion) and had less than $5 million of revenue.

What emerging new technologies are you interested by?

Within healthcare we see opportunities in digital therapeutics, machine learning for diagnosis (in areas with patterns and data such as pathology and radiology) and robotic surgery still has potential for further growth.  Mental health is a huge growth area – any technology to treat patients digitally can provide clinicians with scale, increase adherence, keep patients outside of the clinic and improve outcomes.  Digital phenotyping in, for example, behavioural or neurodegenerative diseases is very interesting too.

Within life science we feel machine learning and robotics to automate processes and drive better outcomes are the most interesting areas.

Joyance Partners is a venture capital investor focussed on start-ups in the health and happiness spaces. Based out of the US and Europe, the firm is currently investing out of its sixth fund.

The team considers some of the key drivers LPs should focus on when evaluating health funds are macro trends such as shifts in consumer behaviour, and a move towards personalised and self-managed care. Paolo Pio, Managing Director for Europe explains Joyance Partners strategy around these trends:

What is the firm’s investment thesis?

Joyance Partners scouts entrepreneurs at the earliest stage possible globally and helps them achieve their mission of making customers healthier and happier. Our moment-of-inception fund finds and interacts with more new companies than others through a blend of active outbound research, analytics, and intense networking. We analyse multiple investment sectors each year and select the areas with the greatest potential for high value Series A rounds and exits.

We scout for and drive the transition from reactive sick-care to proactive health-care, from the ‘one size fits all’ approach typically delivered by pharma, hospitals and insurers, to a personalized paradigm and focus on the individual – that’s where we see emerging opportunities offering high growth potential. Focus areas include Quantitative Self, Preventative Medicine, Personalised Nutrition, Longevity and Fertility.

We’re actively investing in companies on all levels of health and happiness tech – from transforming the human organism (genetics, bioscience), to creating new forms of human chemistry (personal pharma, the microbiome), to reading, understanding or altering our minds (neuroscience), to expanding and changing human experience rather than the body (virtual and augmented reality), and even to altering what we eat and drink (next generation food) and how we interact with one another (emergent community).

Why did you choose this strategy?

By investing at earlier stages than other investors, the fund seeks to gain access to later high value Series A rounds. Since returns are driven by investing in the correct high growth sectors, we rely on deep expertise provided by our tremendous team of 20 specialists, including three life science PhDs, a Medical Doctor, a Bioscientist, two Food/Fitness specialists, and Deep Tech investors).

Focusing on B2C is important to help reduce risks caused by regulation and slow sales cycles, risks inherent in the healthcare sector.

Health and happiness science is the most robust early stage investment opportunity we have seen in decades, a huge opportunity transforming core human experiences, and regulation is moving a lot quicker now as a result of COVID-19. We’re seeing huge advancements in all of: genetics, neuroscience, bioscience, personal pharma, the microbiome, virtual and augmented reality, next generation food, and emergent community.

This is a $15T worldwide market ripe for a fresh perspective beyond the later stage drug and disease focus of common health care funds.