A debt- and equity-financed megafund of up to $30 billion could generate handsome returns for investors backing speculative early-stage cancer drug research and development, says MIT professor and hedge fund manager Andrew Lo.

By creating large, diversified portfolios of as many as 150 projects at all stages of development, and structuring combinations of equity and securitized debt financing, larger than normal capital pools could support costly R&D portfolios, Lo and his colleagues suggest in a paper published in the journal Nature Biotechnology.

Simulating returns based on historical data, Lo estimates a $5 billion to $15 billion megafund may yield average returns of 8.9 percent to 11.4 percent for equity holders and 5 percent to 8 percent for “research-backed obligation” holders, owners of securitized early-stage clinical and preclinical biomedical assets. While those returns are lower than typical venture capital hurdle rates, they may be attractive to pension funds, insurance companies, and other large institutional investors, Lo suggests.

“Consensus is growing that the bench-to-bedside process of translational biomedical research into effective therapeutics is broken,” Lo and his colleagues write. A “trend of increasing complexity and risk implies that the traditional financing vehicles of private and public equity are becoming less effective for funding biopharma because the needs and expectations of limited partners and shareholders are becoming less aligned with the new realities of biomedical innovation.”

Using securitization to finance preclinical or early-stage drug development would set the megafund apart from strategies pursued by venture capitalists and biopharma companies already investing in the sector. A megafund on the order of $5 billion to $30 billion could also differentiate itself by investing in speculative early-stage R&D in exchange for a percentage of future royalties or proceeds from any subsequent sale of the intellectual property, the authors suggest.

Lo and his co-authors partially dismiss worries raised by the role of securitization in the recent financial crisis, writing “securitization was, and continues to be, an effective means of raising capital.” They model a variety of scenarios by which capital could be raised and deployed, concluding that if implementation issues could be addressed, the financing techniques they suggest could “greatly expand the current scale of biomedical innovation.”

Lo is not looking to run the new megafund. He already runs the Cambridge, Massachusetts-based hedge fund AlphaSimplex Group. Instead, he is looking for a team to build and manage it, according to The Boston Globe. The Globe reports he is also planning a conference next year to draw together scientists, investment managers, and potential investors to explore the megafund idea in greater depth.

“Proposing to raise billions of dollars for biomedical research in the current economic climate may seem ill-timed and naïve,” the authors concede. However, they argue, the cost of cancer’s burden must be balanced against the risk of failure.