Healthy prospects
The healthcare sector has long been one of our favoured themes, and it has rewarded over time courtesy of various long-term tailwinds. However, the sector sometimes drifts into the orbit of politics and is buffeted accordingly – particularly when it comes to the US. In recent years this has largely resulted in underperformance given political uncertainty and concerns over tariffs and drug pricing, amongst others – to the point valuations look very attractive. Some of these headwinds now appear to be dissipating and the long-term fundamentals are beginning to reassert themselves. Once again, sunnier uplands beckon though the path will not always be smooth. This is not yet consensus – and therein lies the opportunity.
Long-term tailwinds
Reference is often made to long-term tailwinds while underestimating their significance and worth. Not all sectors benefit from them: some can be cyclical, others temporary, and some barely exist at all. Healthcare is one of the few exceptions. It is subject to fundamental drivers which go to the heart of people’s concerns. These include ageing populations needing more interventions and being better able to afford them, increasingly expectant and emerging middle classes around the world seeking a better and healthier way of life, and robust innovation and productivity providing more hope for many diseases and conditions. In recognising this, the challenge for portfolio managers tends to be one of balancing sector valuations with the extent and duration of the various headwinds.
It is worth first highlighting some of the characteristics of the various tailwinds. Ageing demographics are often cited but rarely quantified. Populations in the western world are not only living longer, but there is predicted in certain countries an acceleration in the 75-84 age range from the baby boomer generation over the next few decades – and this is helping to shift the age dispersion significantly. For example, in the US the number of people aged 75-99 is expected to double to nearly 50 million over this same timeframe. Meanwhile, the multiplier effect needs to be recognised. Figures show spending on healthcare typically rises dramatically from the mid-70s at a time many healthcare systems are struggling with patient waiting times and elective care. Demand is set to remain robust, if not accelerate.
At a point demographics are about to have a material impact on developed markets, the rise of the world’s middle-class courtesy of many emerging economies is also about to significantly impact demand. Billions of wealthier people are looking for better quality healthcare. Due to their low starting points, the sheer scale in growth of healthcare expenditure needs to be recognised. Some estimates suggest that China and India will see an annualised increase in expenditure per capita of 7.7% and 5.5% respectively over the 25 years from 2015. To help quantify this in monetary terms, China is forecast to increase health expenditure from approximately $1.1 trillion in 2021 to US$2.7 trillion by 2032. Many other developing countries are following suit.
And then we come to the third tailwind – innovation. During a period where there is too little growth in the global economy, innovation which secures positive and measurable outcomes will become more highly prized. Healthcare R&D is spawning new and exciting product cycles at an increasing rate, and this productivity is driving revenue and earnings growth. New drug approvals by the Food and Drug Administration (FDA) illustrate the point. Looking at the last three decades (1996-2005, 2006-15, 2016-25), the number of approvals has run 302, 286 and 453 – with 2025 still not through. The trend in the last decade has been very positive. In short, the sector promises innovation in abundance – and at a fraction of the price of the larger US technology companies!
It is worth noting the role played by biotechnology stocks and the subsequent impact when it comes to exposure. This sub-sector is now the engine room of innovation. It was not always thus. Recent commentary has suggested that ten years ago, 70% of new drug approvals originated from the larger pharmaceutical companies. Now the inverse is true, with 70% of approvals emanating from the biotechnology sector. Better technology, including AI, is having a material impact on productivity and allowing smaller companies to better challenge the giants. Little wonder this sub-sector continues to see strong M&A activity as the larger pharma companies look to complement their product ranges as patent cliffs approach. Portfolios should be overweight the sub-sector.
Meanwhile, the headwind alluded to earlier – political uncertainty – is beginning to dissipate. Industry dislikes uncertainty more than probably borderline or even bad government policies, because it can plan for the latter. Concerns about drug pricing and sector tariffs to encourage onshoring are falling away – the recent accommodation between President Trump and Pfizer, and other companies, in the Oval Office has introduced greater clarity as to the way forward. Meanwhile, worries over the impact Robert F. Kennedy Jr may have had on the FDA now seem to be wide of the mark – indeed, it could be argued that the process for drug approvals has been streamlined, and this is contributing to the timely increase in approvals. The sector now appears set on a course away from the orbit of politics.
This brings us to the issue of valuation. The sector has underperformed in recent years and now stands on a 30% discount to its P/E average. Looking back 30 years, it has only fallen to such lows three times, and on the two previous occasions, there followed a strong rebound. For reasons cited above, the rebound this time may be even more sustained. Smaller companies are particularly worthy of note. Given the extent of R&D, they are very sensitive to rising bond yields and discount rates. As such, they have underperformed and, by some measures, sit at 40-year lows. Given the consensus view on bond yields and the good breadth generally in positive earnings revisions, portfolio exposure should be overweight smaller companies and biotechnology – which the ‘generalist’ sector companies are.
Portfolio exposure
The sector has long featured in our portfolios – yet, despite its attractions, being an equity, the extent of exposure has to be balanced against portfolio remits. We should remember that volatility and velocity will accompany this journey, but also that the sector will benefit as the market comes to accommodate a ‘broadening out’ of earnings growth, away from the large US technology companies which have dominated investors’ attention. Below are the portfolios’ key holdings.
Worldwide Healthcare Trust (WWH) invests globally in a diversified portfolio of pharmaceutical, biotechnology and related companies in the healthcare sector. OrbiMed, the manager, is the largest specialist healthcare investment firm in the world and this provides a competitive advantage in what is a highly specialised discipline. In recent years, the company has not escaped the perfect storm affecting the sector, in large part because of its overweight exposure to smaller biotechnology businesses, which have underperformed largely because of the macro-economic environment. This has dented its good long-term record of performance.
Yet, the company’s biotechnology weighting and focus generally on innovation now stands it in good stead – as the latest set of results indicates. This focus is important to understand. As the managers put it: “Despite ongoing volatility within the Healthcare sector over the past four-plus years, the Company has persisted with its long-term recipe for success, namely overweighting the most highly innovative sectors, like Biotechnology and Emerging Markets, and overweighting secular growth sectors like Medical Technology. This is typically at the expense of Pharmaceuticals, a heterogeneous sector of companies at different ends of the innovation spectrum at any given time.”
International Biotechnology Trust (IBT) has outperformed the NASDAQ Biotechnology index over most timeframes under its experienced team. The managers said earlier this year about prospects: “The structural growth drivers underpinning biotechnology remain firmly intact. As populations become older, richer and sicker, demand for healthcare innovation continues to rise … Despite these long-term tailwinds, biotechnology valuations remain at compellingly low levels, particularly among small and mid-capitalisation companies … Biotechnology remains the engine of healthcare innovation.” Meanwhile, the company pays a dividend equivalent to 4% of its NAV which assists those portfolios also looking to income.
BioPharma Credit Investments (BPCR) specialises in lending to the life sciences industry with investments secured by rights and cashflows from the sales of approved products. The company has performed well. It generates a high income, and this is often supplemented by royalty investments, which help to fund special dividends in addition to the regular seven cents. Because of its more defensive nature (i.e. debt rather than equity), the company assists those portfolios seeking diversification and yield.
Disclaimer: The information contained in this article does not constitute investment advice or a personal recommendation and it is not an invitation or inducement to engage in investment activity. You should seek independent financial advice as to the suitability of any investment decision. Past performance is not a guide to future performance. The value of investment company shares, and the income from them, can fall as well as rise. You may not get back the full amount invested and, in some cases, nothing at all.
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