Healthier returns
Perhaps because there is too much focus on short-term returns, the tenets of good portfolio management can sometimes underestimate the importance of identifying long-term structural themes and then nuancing the extent of exposure depending on prevailing sector and market conditions. A good example is the healthcare sector. It has been out of favour for a few years and valuations are attractive. Yet the fundamentals continue to be sound, if not improving, and concerns are overplayed. As such, the sector presents an opportunity for investors.
Doctor’s orders
The sector has long been one of our portfolios’ favoured themes, and one which has performed well over time. Recent figures suggest the MSCI World Healthcare index has steadily outperformed global markets, producing a compound annual return of 12.7% over the last 15 years compared to 10.9% for the MSCI World index. The long-term case for healthcare is well-rehearsed. An ageing and increasingly wealthy population looking for remedies, strong innovation and drug development able to deliver, and a growing middle class particularly in Asia expecting better access to healthcare, are some of the reasons.
And this momentum may surprise by the extent it gathers pace. For example, due to medical advances and healthier living, life expectancy has improved markedly – from 66 years at the turn of the century, to 71 years today. Age demands more and more medical interventions, and perhaps increasingly so as scientific innovation and treatment availability also gathers pace. Yet, despite the long-term case for healthcare, the sector has underperformed in recent years given various concerns – some ephemeral, some less so.
Regulatory concerns, especially in the US, have unduly influenced sentiment in the past. In a Presidential election year, the issues of drug pricing and access to healthcare is again casting a shadow given healthcare is expensive. However, the US Inflation Reduction Act has seen drug price negotiations for many of the highest selling products already announced. As such, a further round of negotiations is unlikely to have a significant impact – particularly as the campaign focus appears elsewhere. Yet, while this is less of an issue this time round, it is nevertheless one that will not go away.
As pressure to spend more continues, the need for fundamental reform will become more apparent in many healthcare systems. Take the NHS. Despite funding being 20% more than the average OECD spend at c.9% of GDP, with France and Germany just behind, our cancer survival rates still lag those of other countries – as long ago as 2009, it was estimated 10,000 lives a year could be saved if this gap were closed. A focus on processes (rather than outcomes to encourage earlier diagnosis) and bloated bureaucracy (around half of NHS staff are not medically trained) have hindered progress.
Other factors accounting for the sector’s recent underperformance include the significant derating of smaller biotechnology companies a few years ago, from which it has only modestly recovered. In addition to the dramatic underperformance of smaller companies more generally, rising interest rates has presented a particular problem for companies in this sector given their high risk/reward profile, as they have sought to raise finance and move on to the next stage of profitability. Given the macroeconomic environment, early funding rounds are suggesting such headwinds may now be easing.
Meanwhile, biotechnology is seeing strong M&A activity given the need for larger pharmaceutical companies to supplement their pipelines, at a time smaller company valuations within this sub-sector remain very attractive. Developing drugs is expensive even for the larger pharma companies, and so bidding for a smaller biotechnology company with a promising product, even if a 100% premium is paid, can often be more cost effective than developing the equivalent from scratch. The figures suggest such corporate activity will not wane any time soon, with more than 20 deals in the first half of this year alone.
Sentiment has perhaps also been impacted by fund managers struggling to keep pace with a sector index where market leadership has been very concentrated. Eli Lilly and Novo Nordisk now account for c.40% of the index following strong share price gains over the last five years largely on the back of their new obesity drugs, which also have been shown to reduce the risk of other conditions including heart failure. Yet the competition in obesity drugs is set to increase markedly, and this should broaden market leadership over time.
Otherwise, the sector’s fundamentals continue to strengthen. Innovation across the sector remains strong with 2023 seeing a record number of new drugs being approved by the US Food & Drug Administration. The advance of technology has enabled great progress. New treatments are being discovered ever faster and more cost-effectively. This year suggests the pace will hardly slacken. The healthcare managers at OrbiMed believe there are over 30 potential new drugs for the treatment of cancer alone. Such progress bodes well for investors and patients, while increasing pressure to reform inefficient healthcare systems.
Investors should also consider another factor – more nuanced perhaps, but no less meaningful. In an investment landscape where shifting sands and styles can conjure unpredictable headwinds, the strong growth in demand for better and more healthcare should make the sector one of the more reliable thematic trends in the years ahead. And this may become a tailwind of increasing strength – periods of underperformance may become less common.
Portfolio picks
The companies below are held across our range of portfolios:
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 dedicated healthcare investment firm in the world. WWH has not escaped the sector’s recent malaise in part because of its focus on smaller biotechnology businesses and underweight position in the larger pharmaceutical companies. This has dented its superb longer-term performance. Yet, in part because of the pickup in M&A and the lowly ratings relative to outlook, its portfolio positioning may now become a tailwind. A double-digit discount when bought adds to the investment case.
Bellevue Healthcare Trust (BBH) again offers broad exposure to the global healthcare industry including pharmaceuticals, biotechnology, medical devices and equipment, healthcare insurers and healthcare information technology sectors, amongst others. The managers run a concentrated portfolio and one that has been somewhat defensively positioned, which helps to account for its pedestrian performance in recent years. However, recent performance looks to be on the turn. A dividend equivalent to 3.5% of the Net Asset Value (NAV), together with a share redemption policy (our portfolios do not participate), helps to keep the discount relatively tight.
Exposure is not restricted to listed equities. Syncona Limited (SYNC) seeks to build and scale companies around exceptional science to create a portfolio of 20-25 leading life science businesses. The company’s structure and strong capital reserves allow a long-term view, while its meaningful exposure to the renowned ‘golden triangle’ of London, Oxford and Cambridge bodes well. It is at an interesting juncture. After years of patient investment, a review of its portfolio is focusing on those pipelines offering the most promise. Meanwhile, several clinical stage companies are in the process of achieving regulatory milestones. A discount of c.35% when bought adequately reflects the inevitable bumps in the road.
BioPharma Credit Investments (BPCR) specialises in lending to the life sciences industry with its investments secured by rights and cashflows from the sales of approved products. The company is managed by Pharmakon Advisors, an experienced and specialist management group based in New York, and has performed well. Given its remit, the company 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 while standing on a 10% discount at time of writing.
We should also not forget the portfolios’ more generalist private equity holdings also boast meaningful sector exposure – examples include Patria Private Equity Trust (PPET), Pantheon International (PIN), HarbourVest Global Private Equity (HVPE) and CT Private Equity Trust (CTPE).
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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