Investing in the Life Sciences Sector – the ESG Approach

Environmental, social, and corporate governance (ESG) analysis is gaining increasing popularity as a key step in the investing process. At its core, ESG analysis is a catch-all term for socially conscious investing; investors apply a comparative framework used to measure a company’s social responsibility against their peers in the same sector. Investors analyze a potential investee’s environmental concerns, societal impact, and corporate ethos to gain a better understanding of the non-financial factors at play within a company.

The methodology is centered around the concept that an investment is only as successful as the intrinsic sustainability and social responsibility of the investee’s business model. Without sustainable development, the investee will degrade over time, thus losing investor capital. By aligning the financial success of a company with conscientious activity, the company is incentivized to create sustainable development activities which in turn benefit society, create a strong return on investment and mitigate an investor’s risk.

Incorporating this tactic into life science investing allows for a more comprehensive view of a company’s outlook and creates a clear impetus for companies to work towards a more sustainable future. The life science specific ESG method boils down to three fundamental steps: screening ethics, analyzing sustainability, and connection maintenance. This review aims to highlight the key features of these umbrellas.

1. Ethics Screen

The ethics screen aims to distinguish companies at an overarching level. Fundamental, technical, and scientific analyses are supplementary to the ESG approach; companies that fail to check the boxes on critical ESG requirements are immediately eliminated from the prospective investment portfolio. Indicators comprised of standard ESG exclusion criterium quickly and efficiently remove companies which fail the moral bare-bones screen. Standard ESG exclusion criteria include previous or current ethical misconduct issues, environmental irresponsibility, human rights violations, gross corruption, fraudulent activities, and poor waste/emission management. Companies that score high in these areas progress to the next stage of investment analysis.

2. Sustainability Analysis

The sustainability analysis is designed to investigate sector-specific ESG metrics. In the life sciences sector, the innovative capability, product development pipeline, corporate governance, climate impact, and accessibility for all are the main areas of focus. These categories should be scrutinized under the lens of the ESG umbrella and then translated into a score-based screen.

2.1. Innovative Capability

The focus on innovation aimed at creating high impact solutions in the life sciences sector is paramount for the success of an investment. Work to create solutions for high mortality diseases, breakthrough therapies, and orphan drug designations for rare conditions, all fall into the high-societal impact group by ESG standards. For instance, the advent of modern medicine has drastically increased the average global lifespan - by 2030, there will be more individuals over the age of sixty than under the age of twenty-four. This population density shift is resulting in an increased incidence of high mortality diseases (cancers, diabetes, obesity, etc) driving the need for novel solutions in their respective treatments. By analyzing the innovative capability of a company, an investor can gain insights into an investee’s ability to follow the needs of the times. Companies working with innovative pipelines in pursuit of cutting-edge therapies are prime examples of highly capable investments.

A focus on rare diseases (which may not impact a large proportion of individuals but are crippling for those affected) can illustrate a strong moral backbone in a biotech company. Companies with breakthrough or orphan drug designations are dedicated to providing concrete change in their field, a clear indicator or innovative capability. In addition, companies with a large percentage of their investments in research and development, a high ratio of PhD level scientists to employees, and good employee turnover clearly indicates a strong drive to innovate in their field.

2.2. Product Development Pipeline and Clinical Trials

The fate of a life sciences company rests upon the outcome of their clinical trials, any dishonest communication of testing results, lack of motivation to share data, or failure to adhere to clinical protocols would result in a fail point on the ESG scale. Clear and transparent study protocols executed by experienced clinical investigators showcase the level of scientific expertise in a life science study. Completion of clinical trials in countries with high regulatory barriers demonstrate a potential investee’s dedication to maintaining the scientific rigor needed to prove clinical relevance. Informative press releases and readily accessible clinical trial data reinforce the transparency of a given study. As far as development pipelines, positive phase II data, and active pursuit of large-scale studies retains a positive outlook for a company.

2.3. Corporate Governance

Corporate governance scores in the ESG framework are centered around the methods by which a given company is managed. This is qualitatively measured by board diversity, shareholder independence, CEO compensation, and overall level of transparency. A diverse board of directors provides varying perspectives, covering more angles, and analyzing a greater range of prospective outcomes. A board independent of the largest shareholders in the company places a life science company in a position to mitigate potential business ethics issues. A strong mission statement, clear core values, and a robust board operating mechanism are all reflective of a transparent relationship between the investee, investors, and the public.

2.4. Climate Impact

While the primary ethics screen aims to eliminate companies with low efforts in mitigating their environmental impact, the secondary climate impact specific screen delves deeper into concrete actions taken by each company. This secondary screen does not play as much of a role in the case of small and medium cap life sciences companies (since companies in this stage are focused on research and development and do not have a large impact on the overall environment). Even so, companies with flagrant offenses in this area or low efforts to implement sustainable climate-related activities will be flagged and removed from the potential investments list. In the case of large-cap life science companies, the environmental impact of their manufacturing processes, research and development, and waste management is all taken into account. Low efforts to maintain sustainable levels of greenhouse gas production, bio waste containment, and emissions of environmentally persistent pharmaceutical pollutants (EPPP) all discredit a large-cap company. Upper-level management responses illustrating a company’s awareness, environmental concerns, and efforts to execute more actionable methods to reduce their emissions, are sufficient to pass ESG standards. Continuous monitoring is paramount to hold companies accountable and assure that they follow through with their environmental protocol implementation.

2.5. Accessibility for All

Accessibility for all takes varying forms depending on the type of life science company in reference. Large-cap pharmaceutical companies have a massive influence on the general public given their role in the medicine manufacturing and distribution supply chain. The manner in which medicine is distributed, equitable pricing policies, and efforts to provide access for hard-to-reach persons are all taken into consideration. The Access to Medicines Index (created by the Bill and Melinda Gates Foundation) provides concrete metrics used to analyze large-cap companies when assessing the level of effort afforded to provide easy access to medicine. Small and medium cap companies (in the process of research and development) should be assessed based on preclinical market strategies to access relevant patient populations. Once companies receive commercial approval, analyses of pricing policies, and continuous accessibility improvement efforts should be taken into consideration.

3. Connection Maintenance

Once the ESG screening is performed, additional due diligence can be executed to determine the fit of an investment. If a potential investee is chosen, the conversation with the company begins.

The key to investing (by ESG standards) is developing and maintaining a strong connection with the company. Continuous engagement aimed at understanding the day to day operations of an investee, their development pipeline, and inner workings of the company, give the investor key insights as to the future success of their investment. If an investor notices a derailment from ESG standards, reemphasizing the importance of the ESG quality metrics can incentivize a company to move back towards more sustainable activities. By promoting the disclosure of ESG related issues, the investor can create awareness of the problem and determine if the investee can successfully develop a solution. A transparent dialogue holds investees accountable and helps mitigate the overall risk of an investment.

Closing Thoughts

Sustainability is a contentious topic in investing; if the pursuit of sustainability cuts into overall performance, there is a clear conflict of interest. There is growing evidence that the management of ESG related metrics is a strong indicator of a company’s future financial performance. Historically, life science companies with high ESG ratings have outperformed their peers and the market sector, leading to a strong return on investments.

The demonstration that successful management of environmental, social, and corporate governance-related factors leads to stronger financial performance, incentivizes investors, and investees to apply ESG analyses to their strategy. Transparent reporting practices, clear sustainability targets, and shareholder cooperation are ideal practices that benefit all parties involved and help work towards a more sustainable future. At the very heart of investing is the concept of putting trust into an investee: the work, morals, and drive of a company must align with an investor’s thus providing the faith needed to invest in their business - ESG is the manifestation of that concept. By applying these practices to life science investing, an investment in a life science company can become an investment in a sustainable future as well as a successful financial decision.