Roger Stein: A bold new way to fund drug research
November 6, 2013
Believe it or not, about 20 years' worth of potentially life-saving drugs are sitting in labs right now, untested. Why? Because they can't get the funding to go to trials; the financial risk is too high. Roger Stein is a finance guy, and he thinks deeply about mitigating risk. He and some colleagues at MIT came up with a promising new financial model that could move hundreds of drugs into the testing pipeline. (Filmed at TED@StateStreet.)Roger Stein
- Financial management expert
Roger Stein wants to bring financial engineering to the world of drug funding. Full bio
Double-click the English subtitles below to play the video.
So this is a picture of my dad and me
at the beach in Far Rockaway,
or actually Rockaway Park.
I'm the one with the blond hair.
My dad's the guy with the cigarette.
It was the '60s. A lot of people smoked back then.
In the summer of 2009,
my dad was diagnosed with lung cancer.
Cancer is one of those things
that actually touches everybody.
If you're a man in the United States of the America,
you've got about a one in two chance
of being diagnosed with cancer during your lifetime.
If you're a woman, you've got
about a one in three chance
of being diagnosed with cancer.
Everybody knows somebody
who's been diagnosed with cancer.
Now, my dad's doing better today,
and part of the reason for that is that
he was able to participate in the trial
of an experimental new drug
that happened to be specially formulated
and very good for his particular kind of cancer.
There are over 200 kinds of cancer.
And what I want to talk about today is
how we can help more people like my dad,
because we have to change the way
we think about raising money
to fund cancer research.
So a while after my dad was diagnosed,
I was having coffee with my friend Andrew Lo.
He's the head of the Laboratory
for Financial Engineering at MIT,
where I also have a position,
and we were talking about cancer.
And Andrew had been doing
his own bits of research,
and one of the things that he had been told
and that he'd learned from studying the literature
was that there's actually a big bottleneck.
It's very difficult to develop new drugs,
and the reason it's difficult to develop new drugs
is because in the early stages of drug development,
the drugs are very risky,
and they're very expensive.
So Andrew asked me if I'd want to
maybe work with him a bit,
work on some of the math and the analytics
and see if we could figure out
something we could do.
Now I'm not a scientist.
You know, I don't know how to build a drug.
And none of my coauthors, Andrew Lo
or Jose Maria Fernandez or David Fagnan --
none of those guys -- are scientists either.
We don't know the first thing about
how to make a cancer drug.
But we know a little bit about risk mitigation
and a little bit about financial engineering,
and so we started thinking, what could we do?
What I'm going to tell you about is some work
we've been doing over the last couple years
that we think could fundamentally change the way
research for cancer and lots
of other things gets done.
We want to let the research drive the funding,
not the other way around.
So in order to get started, let me tell you
how you get a drug financed.
Imagine that you're in your lab --
you're a scientist, you're not like me --
you're a scientist, and you've developed
a new compound that you think might be
therapeutic for somebody with cancer.
Well, what you do is, you test in animals,
you test in test tubes,
but there's this notion of going from the bench
to the bedside,
and in order to get from the bench, the lab,
to the bedside, to the patients,
you've got to get the drug tested.
And the way the drug gets tested is through a series
of, basically, experiments,
through these large, they're called trials,
that they do to determine whether the drug is safe
and whether it works and all these things.
So the FDA has a very specific protocol.
In the first phase of this testing,
which is called testing for toxicity,
it's called Phase I.
In the first phase, you give
the drug to healthy people
and you see if it actually makes them sick.
In other words, are the side effects just so severe
that no matter how much good it does,
it's not going to be worth it?
Does it cause heart attacks, kill people,
liver failure, this kind of thing?
And it turns out, that's a pretty high hurdle.
About a third of all drugs drop out at that point.
In the next phase, you test
to see if the drug's effective,
and what you do there is you
give it to people with cancer
and you see if it actually makes them better.
And that's also a higher hurdle. People drop out.
And in the third phase, you actually
test it on a very large sample,
and what you're trying to determine
is what the right dose is, and also,
is it better than what's available today?
If not, then why build it?
When you're done with all that,
what you have is a very small percentage of drugs
that start the process actually
come out the other side.
So those blue bottles, those blue bottles save lives,
and they're also worth billions,
sometimes billions a year.
So now here's a question:
if I were to ask you, for example,
to make a one-time investment of, say,
200 million dollars
to buy one of those bottles,
so 200 million dollars up front, one time,
to buy one of those bottles,
I won't tell you which one it is,
and in 10 years, I'll tell you whether
you have one of the blue ones.
Does that sound like a good deal for anybody?
No. No, right?
And of course, it's a very, very risky trial position,
and that's why it's very hard to get funding,
but to a first approximation,
that's actually the proposal.
You have to fund these things
from the early stages on. It takes a long time.
So Andrew said to me, he said,
"What if we stop thinking about these as drugs?
What if we start thinking about
them as financial assets?"
They've got really weird payoff
structures and all that,
but let's throw everything we know
about financial engineering at them.
Let's see if we can use all the tricks of the trade
to figure out how to make these drugs
work as financial assets?
Let's create a giant fund.
In finance, we know what to do
with assets that are risky.
You put them in a portfolio
and you try to smooth out the returns.
So we did some math, and it turned out
you could make this work,
but in order to make it work,
you need about 80 to 150 drugs.
Now the good news is, there's plenty of drugs
that are waiting to be tested.
We've been told that there's a backlog
of about 20 years of drugs
that are waiting to be tested but can't be funded.
In fact, that early stage of the funding process,
that Phase I and pre-clinical stuff,
that's actually, in the industry,
called the Valley of Death
because it's where drugs go to die.
It's very hard to for them to get through there,
and of course, if you can't get through there,
you can't get to the later stages.
So we did this math, and we figured out, okay,
well, you know, you need about 80 to, say, 150,
or something like that, drugs.
And then we did a little more math, and we said,
okay, well that's a fund of about
three to 15 billion dollars.
So we kind of created a new problem
by solving the old one.
We were able to get rid of the risk,
but now we need a lot of capital,
and there's only one place to get that kind of capital,
the capital markets.
Venture capitalists don't have it.
Philanthropies don't have it.
But we have to figure out how we can
get people in the capital markets,
who traditionally don't invest in this stuff,
to want to invest in this stuff.
So again, financial engineering was helpful here.
Imagine the megafund actually starts empty,
and what it does is it issues some debt
and some equity,
and that generates cash flow.
That cash flow is used, then, to buy
that big portfolio of drugs that you need,
and those drugs start working their way
through that approval process,
and each time they go through
a next phase of approval,
they gain value.
And most of them don't make it,
but a few of them do,
and with the ones that gain value, you can sell some,
and when you sell them,
you have money to pay the interest on those bonds,
but you also have money to
fund the next round of trials.
It's almost self-funding.
You do that for the course of the transaction,
and when you're done, you liquidate the portfolio,
pay back the bonds, and you can
give the equity holders a nice return.
So that was the theory, and we talked about it
for a bit, we did a bunch of experiments,
and then we said, let's really try to test it.
We spent the next two years doing research.
We talked to hundreds of experts in drug financing
and venture capital.
We talked to people who have developed drugs.
We talked to pharmaceutical companies.
We actually looked at the data for drugs,
over 2,000 drugs that had been approved or denied
and we also ran millions of simulations.
And all that actually took a lot of time.
But when we were done, what we found was something that was sort of surprising.
It was actually feasible to structure that fund
such that when you were done structuring it,
you could actually produce low-risk bonds
that would be attractive to bond holders,
that would give you yields of
about five to eight percent,
and you could produce equity
that would give equity holders
about a 12-percent return.
Now those returns aren't going to be attractive
to a venture capitalist.
Venture capitalists are those guys
who want to make those big bets
and get those billion dollar payoffs.
But it turns out, there are lots of other folks
that would be interested in that.
That's right in the investment sweet spot
of pension funds and 401(k) plans
and all this other stuff.
So we published some articles
in the academic press.
We published articles in medical journals.
We published articles in finance journals.
But it wasn't until we actually
got the popular press interested in this
that we began to get some traction.
We wanted to do something more than
just make people aware of it, though.
We wanted people to get involved.
So what we did was, we actually
took all of our computer code
and made that available online
under an open-source license
to anybody that wanted it.
And you guys can download it today
if you want to run your own experiments
to see if this would work.
And that was really effective, because people
that didn't believe our assumptions
could try their own assumptions
and see how it would work.
Now there's an obvious problem, which is,
is there enough money in
the world to fund this stuff?
I've told you there's enough drugs,
but is there enough money?
There's 100 trillion dollars of capital
currently invested in fixed-income securities.
That's a hundred thousand billion.
There's plenty of money.
But what we realized was that it's
more than just money that's required.
We had to get people motivated,
people to get involved,
and people had to understand this.
And so we started thinking about all
the different things that could go wrong.
What are all the challenges to doing
this that might get in the way?
And we had a long list, and so what we did was
we assigned a bunch of people, including ourselves,
different pieces of this problem,
and we said, could you start
a work stream on credit risk?
Could you start a work stream
on the regulatory aspects?
Could you start a work stream on
how you would actually manage so many projects?
And we had all these experts get together
and do these different work streams,
and then we held a conference.
The conference was held over
the summer, this past summer.
It was an invitation-only conference.
It was sponsored by the American Cancer Society
and done in collaboration
with the National Cancer Institute.
And we had experts from every field
that we thought would be important,
including the government, including
people that run research centers and so on,
and for two days they sat around
and heard the reports
from those five work streams,
and they talked about it.
It was the first time
that the people who could actually make this happen
sat across the table from each other
and had these conversations.
Now these conferences, it's typical to have a dinner,
and at that dinner,
you kind of get to know each other,
sort of like what we're doing here.
I happened to look out the window,
and hand on my heart, I looked out the window
on the night of this conference --
it was the summertime --
and that's what I saw, it was a double rainbow.
So I'd like to think it was a good sign.
Since the conference, we've got people working
between Paris and San Francisco,
lots of different folks working on this
to try to see if we can really make it happen.
We're not looking to start a fund,
but we want somebody else to do this.
Because, again, I'm not a scientist.
I can't build a drug.
I'm never going to have enough money
to fund even one of those trials.
But all of us together, with our 401(k)'s,
with our 529 plans, with our pension plans,
all of us together can actually fund hundreds of trials
and get paid well for doing it
and save millions of lives like my dad.
- Financial management expert
Roger Stein wants to bring financial engineering to the world of drug funding.Why you should listen
Roger Stein is a senior lecturer in finance at MIT's Sloan School of Management and a research affiliate at the MIT Laboratory for Financial Engineering. He is also the former chief analytics officer at State Street Global Exchange. He has been working in risk modeling and financial prediction for almost 25 years; his products and services are used widely in industry and have become benchmarks in banking and finance. With MIT colleagues, he is currently collaborating on a new model that uses modern risk management methods and financial engineering techniques to change the way new drug research is funded.
Previously he was managing director of research and academic relations globally for Moody’s Corporation, and prior to that was president of Moody’s Research Labs. He has a Ph.D. from New York University, has coauthored two full-length texts on applied analytics, and has written more than 50 academic articles and papers. He has also been practicing Aikido since 1980.
The original video is available on TED.com