Andrew Lo – MIT professor
If you are under 30, you probably use Facebook all the time. I’m not part of that demographic, so I don’t. But if I did, these are some of the photos that would be on my Facebook page: pictures of my friends, colleagues, and my mom. These people have one other thing in common besides me, they all died of cancer within the last few years. Cancer is personal for me, as I am sure it is for many of you.
So, by a show of hands, how many people here have dealt with cancer directly or have friends or family that are dealing with cancer? Yeah. Cancer touches all of us. So, I know that grieving is supposed to have five stages: denial, anger, bargaining, depression and acceptance. I probably won’t make it to acceptance, because I am still stuck on anger.
I’m sick and tired of losing friends and family to cancer, and I don’t accept it and neither should you. But what can I do? I’m just a financial economist. And cancer patients need a financial economist like a fish needs a 401(k) plan. But as I learned more about cancer and the business of cancer drug development, I now believe that financial engineering can play a major role in curing cancer.
Now before I tell you how I came to that strange conclusion, I need to make a disclaimer. You know, like the warning on drug commercials? I may cause disorientation, confusion or drowsiness, but they should all pass within 18 minutes. The real disclaimer is that I have no background in biomedicine. I’m not part of the biomedical industry, but like all of you who have friends or family with cancer, I want to help.
And four observations have convinced me that the financial industry and all of us can do a lot to bring cures to cancer patients faster.
The first observation is that drug development is getting harder and harder all the time, not easier. What’s the evidence? Here’s a graph titled “Eroom’s law” from an article on the efficiency of the pharmaceutical industry. The horizontal axis is time, and the vertical axis is this measure of efficiency, the number of new drugs approved by the FDA each year per billion dollars of R&D spending. And it’s been declining for decades. In case you are wondering, “Eroom’s law” stands for the opposite of “Moore’s law.” This is the exact opposite of what we’re experiencing in semiconductors, where we’re getting more and more efficient all the time.
Why is this happening? Especially when we’re getting smarter, year after year, thanks to all the breakthroughs made by scientists, clinicians and drug developers just in the last ten years. Well, it’s partly because we’re getting smarter that drug development is getting harder and financially riskier. I know that sounds counter-intuitive. Usually when we get smarter, things get easier and less risky, but it’s just the opposite in biomedicine.
As we learned more about the complexity of human biology and disease, we realized that there are many many things that can go wrong and a lot of possibilities for either fixing or preventing them from happening. And because of scientific and ethical reasons, we have to test each of those possibilities with a separate and independent clinical trial. And each clinical trial takes years and thousands of patients and hundreds of millions of dollars, which somebody has to pay for.
And that brings me to my second observation, which is that funding is declining because financial risk is increasing. So let’s talk about financial risk. It turns out, that most clinical trials are done by big drug companies. But ultimately, it’s the investors in those companies that have to pay for those trials, including you and me.
And here’s a fact about those costs. We like return, but we don’t like risk. And I’m going to give you an illustration of that. I’m going to show you an investment of a dollar in four different financial assets. I’m not going to tell you what they are, or even over what time span they last. I want you to take a look at these four assets, and tell me which one you would prefer if you could only have one. Try to balance the risk-reward trade-off for your own preferences.
Okay, by a show of hands, how many people want the green asset? Okay, how about the red asset? All right. How about the blue one? A few hands. And how about the yellow one? Yeah. Let the record show that most of you want the yellow asset.
Well, let me tell you what you all chose. First, the time span is from 1990 to 2008, and the first asset, the green one, is US Treasury bills, the safest asset in the world but not very attractive in terms of return. The second asset is the S&P 500, the US stock market: more return but more risk. The third asset, the blue asset, is Pfizer, the drug company, and it’s got an even better return but a lot more risk. Now what about the yellow asset? The one that most of you picked. The yellow asset is the feeder fund for the Bernie Madoff Ponzi scheme. And that’s why it ends in 2008. We all want more return and less risk; it’s human nature.
Now let me ask you about a second investment opportunity. This investment requires an upfront payment of 200 million dollars. It takes 10 years, where you get nothing in between, and in year 10, your payoff depends on drawing a ball from this urn. The urn has 20 balls, 19 of them are yellow, one of them red. And if you draw a yellow ball, you get nothing. But if you draw the red ball, you get 12.3 billion dollars! A fantastic payday, but remember, you only have a one out of 20 chance of picking that ball. 19 out of 20 times you get nothing.
So by a show of hands, how many people want this investment? Yeah. Not too many takers.
Well, these are the back-of-the-envelope, typical numbers for investment in a single anti-cancer drug candidate. And it’s just not that compelling. In the history of Major League Baseball, the player with the lowest batting average of all time was a catcher from the Cincinnati Reds named Bill Bergen, who in 1909 batted 139. 139 is the lowest batting average in baseball history. And it’s almost three times the number of hits you can expect from cancer drug development. It’s just too risky. And these statistics, they have an impact on biomedical funding and on patients.
When my mother was dealing with lung cancer, I was introduced to a very successful biotech company developing an experimental therapy for this disease. I was privileged to meet with the chief scientific officer as well as the chief financial officer, and I asked what I thought was an innocent question. I asked them if their financing had any influence on their scientific agenda. The chief scientific officer looked to a CFO, shook his head sadly, turned back at me and said, “Influence? Our financing drives our scientific agenda.”
Now, as an economist, I guess I understand, but as the son of a dying patient, I was absolutely outraged. What do interest rates, stock market volatility and Fed policy have to do with whether you should treat non-small cell lung cancer with angiogenesis inhibitors or immunotherapy? Nothing. But it drives their scientific agenda. Now, I’m no scientist, but shouldn’t the science drive the financing? The problem is, investors don’t like risk.
But sometimes, the most innovative therapies are the riskiest. When you are swinging for the fences and going for home runs, you’re going to strike out a lot more than when you go for singles and doubles. David Ortiz is a good example. So, drug development is getting harder, financial risk is getting bigger and funding is getting lower. What do we do about this?
Well, what if we used financial engineering to improve the odds of cancer drug development? That brings me to my third point, which is that finance can help lower risk. We do it all the time. Here’s how.
Instead of investing in one project at a time, let’s invest in a portfolio of a hundred and fifty projects all at the same time. I know this sounds crazy. First, you need 150 times 200 million or 30 billion dollars. Where are you going to get that kind of money? As an economist, I have a simple answer. Assume we have 30 billion dollars. I’ll come back to that.
But second, if you don’t want one of these projects, why on earth would you want 150 of them? Well, you’ve heard the old saying, “If at first you don’t succeed, try, try again.” What if we could try, try again all at the same time, 150 times. If we did that, the chances of getting at least three hits out of 150 independent trials is a stunning 98%. A 98% chance of getting at least three hits in 150 times at bat. By the way, 98% is more than double Ted Williams’ batting average of 406. And if you got at least three hits, what would your portfolio be worth? Well, three times 12.3 billion or 37 billion dollars in year 10. This is Moneyball for cancer drug development.
Now what about the first issue, where do we get the 30 billion? Well, if you have a 98% chance of producing 37 billion dollars in year 10, it turns out that you can finance the vast majority of that 30 billion by issuing long-term bonds. And if we use all the other tricks of the financial trade, things like collateralized debt obligations, credit default swaps and derivatives securities, we can do even better.
Now, I know what you’re thinking, “Really? We really want to do this?” “Didn’t these techniques figure prominently in the financial crisis?” And I have to tell you that it was studying the financial crisis that got me thinking along these lines. The financial crisis didn’t happen because these techniques didn’t work. It happened because these techniques worked way too well. In fact, these techniques are called ”financial weapons of mass destruction” for a reason. There’s tremendous power locked up in financial markets around the world. And if that power is unleashed in an uncontrolled and irresponsible way – (Blast!) I’ve always wanted to do that – you get devastation and years of nuclear fallout. But the analogy also applies at the other extreme.
If we use these tools carefully and responsibly, we get virtually unlimited power for fueling innovation and economic growth. It works both ways. So let me give you the positive extreme.
Imagine creating a multi-billion-dollar cancer mega-fund managed by the world’s experts in biomedicine and health care investing. Imagine this fund invests in a large number of really risky, but potentially life-saving cancer therapies. I’m talking cures, not just two or three extra months of suffering for cancer patients. And imagine if this fund were financed by cancer bonds that we could all invest in, like the war bonds that the US government issued to finance World War II. 85 million Americans invested in war bonds, and by 1946 we had raised a 185 billion dollars for the war effort. That translates into 2.3 trillion dollars today. It’s a crazy amount of money. And we can finance the war on cancer in exactly the same way.
The research that my collaborators and I have been doing – and I have to give a lot of credit to my collaborators. I couldn’t have done this by myself, fantastic team we have – we found that investments in these kind of securities can actually earn reasonable rates of return for investors if they’re structured in the right way.
This brings me to my fourth and most important observation. The importance of expectations and vision. So, just throwing money at this problem is not enough. We need to know how to use the money well. And as an outsider to the biomedical industry, I’m not qualified to manage a cancer mega-fund, nor am I trying to start one, so please don’t send me your money. That’s the first time a finance professor has ever said those words in public. But I’ve had the great good fortune of meeting a number of people who are supremely qualified to manage this mega-fund as well as a large number of investors who would be delighted to invest if it were structured properly.
The work that we’re doing at MIT is to develop the financial models that bring these two groups together. Financial markets are all about expectation and vision. If investors expect that you can cure cancer, if they share your vision, believe me, they’ll be more than happy to finance all of it. With the right expectations, the right financing and the right vision, we can accomplish amazing things.
I want to leave you with a really powerful example of that vision, which has to do with Harvey Lodish, an MIT colleague of mine who is a cell biologist at the Whitehead Institute. When I first heard the story, I decided I want to be Harvey Lodish. And let me tell you why.
In 1983, Harvey co-founded a small biotech company focused on developing therapies for Gaucher’s disease, a rare genetic disorder that affects maybe one in 20,000 births here in the US. This condition is caused by a mutation, a typo in your DNA, that prevents your body from producing an important housekeeping enzyme that breaks down fatty substances. Without this enzyme, these fatty substances accumulate in your organs, causing all sorts of trouble for your liver, your spleen and bone development.
For many Gaucher’s patients in 1983 this was a terminal illness. Not anymore. Harvey helped to develop a method to replace this missing enzyme in Gaucher patients. And in 1991, the drug Ceredase was approved. That drug and his newer versions have saved many thousands of lives over the course of the last several years. That startup, it’s called Genzyme. In 2011, Sanofi acquired them for 20 billion dollars.
Now, that’s not why I want to be Harvey Lodish. I want to be Harvey Lodish because of what happened in 2002. That year, Harvey’s daughter gave birth to her first child, Harvey and his wife’s first grandchild. A boy named Andrew – great name by the way. Andrew was born with the mutation for Gaucher’s disease. What are the chances? Just because you have the mutation, it doesn’t mean you get the disease right away, but when Andrew turned 10 in 2012, he started developing the symptoms. But he’s just fine, leading a perfectly normal and healthy life thanks to the drug that his grandpa developed over a decade before he was born. When Harvey was doing his work in the 1980s, he never imagined that his work would one day save the life of his grandson. Pretty cool, huh?
This is why I want to be Harvey Lodish. I’ve never had the privilege of saving another life, never mind the lives of my two boys or my future grandchildren or my mom. I can’t. I’m not an MD. My PhD is not in cell biology. I’m just a financial economist. But you and I, we can both be Harvey Lodish if there were a mega-fund that we invested in and which could someday finance cures for our grandchildren’s illnesses whether they be cancer, Alzheimer’s or rare genetic conditions like Gaucher’s.
I know that talking about investment rates of return in the same breath as life-and-death issues like cancer may seem incredibly callous and offensive. My mother died of cancer, so believe me, I get it. But if we don’t talk about investment rates of return, we’re not going to get the amount of funding we need to deal with these terrible afflictions. With the right kinds of financing, we can cure cancer and many other diseases. Finance does not have to be a zero-sum game, if we don’t let it. We can do well, by doing good. And if we work together, we can do it now. Thank you.