If there is one sector that will surely emerge from the coronavirus pandemic in stronger shape, it is healthcare. Increasing global prosperity, scientific advances and the consequent steady increase in demand have made this one of the top growth sectors, although regulation and politics have often got in the way. As a result, it has been a sector that hasn’t quite lived up to its promise.
Growth on the cheap
In a note earlier this month, US investment strategist Ed Yardeni pointed out that the healthcare sector in the US, which dominates its global counterparts, traded on a 15% discount to the S&P 500 based on forward price/earnings (p/e) ratios, having underperformed by 10% since the start of 2018. Yet earnings growth, 16% in 2018, nearly 10% in 2019 and expected to be 8% in 2020, compared favourably with the overall market.
The coronavirus crisis was already putting the healthcare sector in the spotlight, but Yardeni pointed to another significantly positive factor: the faltering campaign of Bernie Sanders for the Democratic party presidential nomination, as shown by the “Super Tuesday” primaries. Sanders has called for the socialising of medicine via “medicare for all” and has the sector firmly in his sights. “Every candidate but one is bullish for the sector,” Trevor Polischuk, co-manager of the Worldwide Healthcare Trust (LSE: WWH), had said a few weeks earlier, “and Joe Biden, the inheritor of Obamacare, represents goldilocks.”
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The pricing row will abate
Drug pricing in the US will remain politically controversial, but Polischuk pointed out that prescription medicines account for just 14% of US healthcare spending, only half of which is accounted for by branded, patent-protected drugs, prices of which had begun to fall in 2019. “The most likely outcome is that nothing will happen on drug pricing,” he said, “as the true inflation is in other areas.”
Not that WWH or its sister trust Biotechnology Growth (LSE: BIOG), also managed by OrbiMed Capital, were exactly suffering from the uncertainty. In 2019, WWH returned 32%, 18% ahead of the MSCI World Healthcare sector, and BIOG 47%, 19% ahead of the Nasdaq Biotech index.
“It was one of OrbiMed’s best years,” said Poliuschuk “and the benchmarks are not easy to beat.” Key reasons for the strong performance included merger and acquisition activity and a favourable regulatory climate. Scott Gottlieb, commissioner of the Food and Drug Administration (FDA), had introduced a series of policies to speed up drug approval and his successor is expected to continue them. They “have reduced the time, cost and approval risk of new drugs”.
Ten potential blockbusters
In addition, “innovation has been as strong as it has ever been”. Polischuk listed ten drug approvals with blockbuster sales potential and many more making significant clinical progress in trials. Emerging markets, especially China, have presented a growing number of opportunities and WWH’s stock selection, helped by moderate gearing, has clearly been strong.
Biotechnology, both the emerging companies (which WWH favours) and the large established ones such as Biogen and Gilead Sciences, account for less than 30% of WWH’s portfolio, but nearly all of BIOG’s. Geoff Hsu, BIOG’s co-manager, pointed out that large biotech companies were trading at a record low p/e ratio of scarcely ten.
“Emerging biotech, which now represents 73% of late-stage research, is where the innovation is happening,” he says. As a result, the portfolio (then $565m) had rather more holdings than historically: 56 rather than between 35 and 40.
The much larger WWH, with $2.2bn of assets, has 90 holdings, a number that is expected to come down. In addition to biotechnology, there is similar-sized exposure to the vertically integrated (they have control of their own supply chains) pharmaceutical companies such as Merck and Novartis, lesser exposure to medical technology and emerging markets and moderate exposure to healthcare services and life-sciences companies, such as Thermo Fisher Scientific. As far as Covid-19 is concerned, Polischuk a few weeks ago predicted “high spread, low mortality” compared with previous virus outbreaks. Stocks should recover once the outbreak is under control.
A possible vaccine?
He pointed to Gilead’s remdesivir as having potential efficacy against the virus and CanSino Biologics as having a promising vaccine treatment.
Covid-19 may not have the devastating long-term impact many fear, but it is unlikely to be the last pandemic. That recognition must surely change public and political attitudes to spending on healthcare.
Though Polischuk and Hsu were bullish, share prices of £10 for BIOG and £33 for WWH gave investors vertigo. However, over the past few weeks these prices have fallen by 20%, but both have outperformed the market, as has their equally impressive newer competitor, BB Healthcare (LSE: BBH). This is surely time to grasp the increased opportunity in healthcare at a much reduced price.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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