Visualizing Pharma’s Real Trade-offs: The Discrete Efficient Frontier Explained

At last week's Marcus Evans Group conference in Edison, NJ, I engaged in several discussions about the efficient frontier—a concept introduced by Nobel Laureate Harry Markowitz.

Traditionally, the efficient frontier is depicted as a smooth, hyperbolic curve representing the set of optimal portfolios offering the highest expected return for a given level of risk, or the lowest risk for a given expected return. This curve delineates the boundary where all possible investment strategies lie, with the return on investment (ROI) on the Y-axis and standard deviation (SD) on the X-axis.

In drug development portfolios, our investment decisions are discrete—we either fund a study or we don't. Consequently, our efficient frontier isn't a continuous curve but a series of discrete points. For illustration, consider a portfolio comprising ten assets at various development stages, each with distinct costs, risks, and value propositions. This setup yields 2^10 potential portfolio combinations, each with its expected ROI and associated SD. When plotted, these combinations form a set of discrete opportunities.

By identifying the portfolios that offer the highest ROI for a given SD, we establish our discrete efficient frontier (see the green circles in the picture)

This approach aligns closely with Markowitz's original concept, adapted to the unique characteristics of our industry.

Please let me know what you think about this method in the comments. How does your company define and utilize the efficient frontier in its investment strategies?