At midnight a couple of days ago the FDA announced the approval Biogen's Alzheimer's drug aducanumab.

Usually when a drug is approved it's cause for celebration, the culmination of perhaps decades of academic and clinical work. The moment is hugely meaningful for patients, doctors, and their families. 

Not in this case. The FDA's independent scientific panel and own statisticians concluded this drug had no measurable effect. 

Aducanumab was tested in two well designed Phase III trials. They were double-blind, placebo-controlled, dose-ranging, and most important of all, with thousands of patients around the world, they were large enough to power a result. If this drug had any significant effect, it had plenty of opportunity to show it.

Instead, the trials were halted early for futility and the drug caused dangerous brain swelling in some 40% of recipients. Which makes the decision all the more surprising. 

When China and Russia announced they had coronavirus vaccines, the world ignored them and looked to the FDA. This is the institution that stood alone against thalidomide. And this week it approved a drug with no evidence of efficacy. 

Biogen tortured the data, mixing patients from one study where the drug had a marginal benefit, with the other, that showed a marginal decline. This sort of post-hoc data mixing to prove a point is a statistical crime.

The FDA didn't approve on this sketchy basis, but rather because the drug cleared amyloid beta plaques. And it was on this, rather than Biogen's shonky data manipulation, that the drug was approved.

Long-time readers will know that we share the increasingly common view that amyloid beta hypothesis is flawed as:
1) every drug that clears amyloid beta fails to show any clinical benefit (there have been many), and
2) many people die naturally with plenty of amyloid beta in their brains, but never get Alzheimer's. 

A hypothesis that actually fits the medical data is that amyloid beta is an effect, not a cause.

The situation is worsened by Biogen's commercial cynicism.

Analysts coalesced around a $10k annual cost estimate for the drug, with the highest at $25k. Biogen has stated they will charge US$56k pa, for a chronic disease that lasts years. 

The FDA asked Biogen to conduct a confirmatory study to prove the drug's effectiveness.

Biogen promptly announced they complete this trial in 2030, giving almost a decade to sell a dangerous, useless drug... and that's before the inevitable delays. We can be sure this study will be done as slowly as possible.

The FDA made a similar call with Sarepta, approving a drug against their own expert advice, on condition of a confirmatory trial. Five years later, the trial has not been done. Why would any company pay money to kill their golden goose?

In another Biogen-friendly curiosity, the FDA approved the drug for all Alzheimer's patients, not just those with early stage disease or with particular biomarkers. There are over 5 million Alzheimer's patients in the US, so the cost of this could exceed US$100 billion a year. That is enough to move the needle on the entire US medical system. This decision could blow back hard onto the pharmaceutical industry.

As one of our advisors put it, it will be quite some time before the full ramifications become clear. 

Recently there has been a flurry of research into alternative theoriers that fit the data, offer new clinical targets, and in early stage trials have demonstrated a clinical effect. We have small investments in two of these. The FDA's decision will starve these alternative approaches of oxygen. The rational move for every company with a failed beta-amyloid drug is now to resurrect it.

Patient advocacy groups, weaponized by Biogen, have something to answer for here.

The correct approach would have been to allow Biogen to conduct a further study, if they so wished, to prove the drug worked. 

It's early days, but this looks like the biggest scandal in pharma since Valeant and Bill Ackman's corporate skullduggery led to the methodical axing of R&D departments several years ago. Three members of the FDA's advisory panel have already resigned in protest. 

In Biogen, a new corporate villain has been born.

Disclaimer

The information in this note has been prepared and issued by Frazis Capital Partners Pty Ltd ABN 16 625 521 986 as a corporate authorised representative (CAR No. 1263393) of Frazis Capital Management Pty Ltd ABN 91 638 965 910 AFSL 521445. The Frazis Fund is open to wholesale investors only, as defined in the Corporations Act 2001 (Cth). The Company is not authorised to provide financial product advice to retail clients and information provided does not constitute financial product advice to retail clients.

The information provided is for general information purposes only, and does not take into account the personal circumstances or needs of investors. The Company and its directors or employees or associates will use their endeavours to ensure that the information is accurate as at the time of its publication.  Notwithstanding this, the Company excludes any representation or warranty as to the accuracy, reliability, or completeness of the information contained on the company website and published documents.​

The past results of the Company's investment strategy do not necessarily guarantee the future performance or profitability of any investment strategies devised or suggested by the Company.​

The Company, and its directors or employees or associates, do not guarantee the performance of any financial product or investment decision made in reliance of any material in this document. The Company does not accept any loss or liability which may be suffered by a reader of this document.

We have seen a range of increasingly interventionist monetary policies unleashed over the last 20 years, and we're now solidly onto the next version. This one will be loose money and loose fiscal. Should be fun, as long as you are prepared for inflation. 

Inflation is now here. It really never went away. Hedonic methods of calculating what was already an imprecise gauge of price changes, have obfuscated, and of course lowered, the official figures. If you wish to see what pre-hedonic calculations would have gauged inflation levels to be today, check out the two charts below on inflation as per the 1990 methodology and the 1980 methodology. Both are by courtesy of shadowstats whose authors provide a plethora of 'real' economic data. www.shadowstats.com

We now actually have an admission of sorts that inflation is here and, woops, higher than promised. Don't wait for any apology. There won't be one.

https://www.zerohedge.com/markets/yellen-admits-inflation-about-soar-says-it-will-be-plus-society

To be fair it's not entirely the current Administration's fault. The asymmetrical approach to interest rates, inflation and sound money in general, started with 'Maestro' and has snowballed since.

Nonetheless a perverse sort of Gresham's Law is applying here - bad policies continue to drive out good. Inflation is the new good thing, and we should welcome it. Yet as Ronald Reagan said in 1978, "Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man."

Memories indeed are short. We are potentially near the end of the liberal era of economic policy with which Regan and Thatcher were associated. Prepare for more government, more rules, and different risks.

Since none of us is going to be in charge of macro-economic policy (at least anytime soon) and we have to invest to maintain our spending power in real terms, against this backdrop of understated inflation and carefully massaged negative real interest rates, how should we proceed?

The answer is to invest in certain equities which are better inflation hedged and which simultaneously provide a better hedge against risk of catastrophic corporate failure.

Do not ignore equities even if you are at an 'advanced age'. Conventional wisdom states that the allocation to fixed interest should rise as you get older. A rule of thumb is that you should have your age as a % in fixed income. So, at 60, you should have 60% in bonds. At current levels of interest rates and inflation, this will almost certainly guarantee an erosion in real purchasing power. Don't do it!

Inflation and corporate failure hedges

Two dimensions should be used to assess which are the better equities to currently overweight if you wish to buy inflation protection. One is Governance as in the 'G' in "ESG" (We think ESG is still improperly used); the other is sector membership and the stability of revenue growth and asset base. Both have an impact on returns, downside protection and survivability.

Below we show how and why better Governed companies have a better survival rate and thus should have a lower discount rate applied to their dividends. These companies are still currently undervalued.

We then show that in the last 40 years, the risk of catastrophic loss in certain USA sectors has been much greater in some than others. Any investor with a time horizon beyond 5 minutes should thus weight their equity exposure to companies in these sectors.

We have written before on ESG and why we think G is relevant as a risk factor but not necessarily as an alpha factor. We show again below the wide range of ESG cores from different ESG ratings agencies, courtesy of Northfield. No alignment here which implies there is no single ESG standard that can be applied.

This article provides a recent assessment of ESG scores and how they are barely useful. https://www.ipe.com/viewpoint-why-companies-and-investors-must-leave-esg-ratings-behind/10053120.article

Nonetheless, good G as measured by its impact on corporate financials, IS useful. Sensible leverage, correct levels of re-investment, and staff retention are all part of any Fundamental or Qualitative assessment in deriving the correct discount rate to apply to a companies' future earnings. Good G can justify lower discount rates through higher survival rates, and thus lower risk.

Below is some analysis of the performance of high G companies in a crisis. Think of it as built-in downside protection to favour high G companies.

Sector membership matters too with respect to survival rates. Most companies do not last. Many companies fail and will continue to fail. Go back and watch any sporting event from 40 years ago. How many of the companies on the advertising billboards are still around today?

What really hurts compounding of returns is a catastrophic loss of capital; it only takes a few stocks to seriously fall for the poorly designed portfolio to suffer serious damage. So how to avoid this risk, and not expose your wealth to risk of failure? Check out the table below drawn from Factset and Refinitiv data.

So, a 70% decline in price aka catastrophic loss, hurts 40% of all listed USA stocks. However, some sectors have historically seen more casualties than others.

If you wish to be safer, especially at this juncture, then look within Utilities, Consumer Staples, Financials Materials and Industrials. By market cap these comprise much less than half of the stock market so active management will prove its worth here.

Companies meeting these two criteria of good G and sector membership, are priced and behave as "index linked corporate bonds". In this regard they are unique. They provide a decent yield compared to the pitifully low or even negative rate on 'safe' government bonds and the current yield on index linked bonds, which of course is negative; AND they offer a measure of hedge against inflation since equities are a claim on nominal growth which conventional bonds are not. Index Linked bonds do provide a hedge against inflation but with negative yields, they are expensive. Buying an index linked bond with a negative yield of 1.5% and not a utility company with a dividend yield of 4% is giving up annually, a 5.5% return.

Equities we own which meet these criteria are in the Global Listed Infrastructure Strategy and the Global Equity Strategy. They include AES, Quanta Services, Johnson Controls, OneOK, Enbridge, Terna, ENEL, Rubis, General Mills, Kroger, Iron Mountain, ENN, Hydro One and Verizon.

We view this as getting a yield in line with corporate bonds, AND the index linking of an inflation proof bond. These companies will have a greater chance of survival in the long run if history is a guide.

The chances of a macro policy misstep are now high, so this is the time to be thinking about survivor strategies.

Here is a slide of returns over the last 18 years accruing to equities, government bonds, infrastructure equities and blends of each. Even during this period of 'growth' equity excitement, one didn't lose out too much by having exposure to defensive stocks in sectors with high chances of surviving a shock.

Currently therefore we are overweight Utilities, Infrastructure and Industrials. Given their superior survival characteristics, their lower P/E multiples and higher dividend yields they look attractive. Add in the likely buying frenzy to be unleashed as other investors scramble to get behind the newly discovered infrastructure spending plans in the USA and Europe, the best place to have risk would appear to be in these companies rather than the now very vulnerable to regulation, non-tax paying, non-voting share class issuing, expensive stocks of yesteryear.

The great thing about the stock market is that complacency, one trick ponies, and luck, get found out over time. Betting on price momentum with an absence of thoughtful, rigorous, analysis on valuations, risks, and portfolio construction tools and without any knowledge of long-term history, is a disaster waiting to happen.