February 24, 2012

Dermatology Risk-Reward

"Anonymous" asked (paraphrasing), if the psoriasis Phase 2c efficacy results were average to good, why was there not as much of a chance or likelihood of no deal as much as my post suggested [to him or her] the chance or likelihood of a deal.

My daughter, in her Grade 4 English class, is learning about analogies. Try this: Risk (volatility of returns) is to reward (returns) [in investing or trading] as safety is to efficacy [in biopharmaceuticals]. Please also read my Dermapalooza post, which I linked to in the same recent post that confused Anonymous.

In investing or trading, the risk-return or risk-reward tradeoff is the principle that potential return rises with an increase in risk (source here). Low levels of risk (i.e., low levels of the volatility of returns, like the volatility of holding a government bond) are associated with low potential returns (i.e., low interest rates or yield on the bond), whereas high levels of risk are associated with high potential returns (i.e., like holding a stock). In investing or trading, we seek (through style and strategy) to decrease risk and increase return in conflict with this so-called principle. In choosing between investment A and investment B, assuming the same level of risk for each investment, you would choose the investment with the higher level of return. The flip side of this: Assuming the same level of return, you would choose the investment with the lower level of risk.

Now, consider safety as risk and efficacy as return.

Big (derm) pharma understands this: (a) efficacy should (will) go up as design constraints of PH-10's previous Phase 2c trial are relaxed and (b) PH-10's safety profile is unlikely to (will not) negatively change. Doing a deal with a large derm pharma company is as much about what management has demonstrated in prior clinical trials, together with showing a well-protected IP portfolio, a plethora of (recent) safety tests, and ease of manufacturing, among other things, as it is about what the pivotal Phase 3 trial is likely to produce by way of efficacy results.

Mixing my analogies, PH-10 has a very high Sharpe ratio (management is generating lots of alpha).

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