The re-rating of the US market has been led by technology-related companies, but the healthcare sector is lagging. According to Paul Major, fund manager of the BB Healthcare Trust (LSE: BBH), the S&P 500 Health Care Sector trades on a multiple of 18 times expected earnings, similar to where it has been in the last four or five years, but at a 20% discount to the overall market.
This is despite what Major calls “unquestionably, one of the greatest achievements of humanity – the delivery of six vaccines for a completely novel pathogen inside of 12 months”. This has not been an isolated example of innovation but part of an acceleration in medical advances encouraged by the relentless growth of demand. “Healthcare is a disproportionate beneficiary of rising wealth. As the world gets richer, healthcare spending per capita rises. Where else can one be certain that demand will rise continually?”
Relentless demand growth
“Moreover, healthcare spending correlates strongly with age and, as people live longer, the global population is ageing.” In the UK, healthcare spending for a 20-year-old averages £1,000 per annum but doubles at the age of 50, doubles again at 70 and reaches £10,000 at the age of 90. At 65, 80% of the population “have at least one chronic medical condition”.
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The increase in healthcare spending is “unstoppable and uncorrelated to economic growth”. Meanwhile, Covid-19 has demonstrated “the need for investment in greater capacity and preventative medicine.” The problem is that somebody has to pay for this.
In the US healthcare spending, 7% of GDP in 1980, has reached 18%. So governments have three options: “They can carry on as they are, allowing healthcare spending to eat all our marginal wealth creation. They can, as in the UK, choose to restrict the growth in healthcare costs to that of GDP, which leads to a chronically under-resourced system. Or they can change the system fundamentally.” Given the time horizons of politicians, they alternate between options one and two.
Improving efficiency
BBH, however, aims to expose investors to the companies that will lead the inevitable transformation of healthcare. “In the UK, one in four healthcare appointments are deemed not to have been medically necessary while 25%-30% of frontline care staff time is spent on paperwork. Technologies, products and services that introduce efficiencies and better decision-making into the system offer tremendous value creation.”
The trust, now with £1bn of assets, trades at a small premium to net asset value (NAV) and yields 2.6%, paid out of capital. It was launched in 2016 to invest in a maximum of 35 listed companies without regard to geography, the size of companies or any benchmark index. The investment return over one year has been 58% and 113% since inception, 42% ahead of the MSCI World Health Care index.
This puts BBH ahead of OrbiMed’s Worldwide Healthcare Trust and on a par with the Biotech Growth Trust in performance terms, although its portfolio sits between them in terms of its spread of investments and the relative emphasis on defensive versus growth stocks. “Innovation won’t be coming from the likes of Glaxo,” says Major. “Specialist managers like us” must find the stocks nobody has heard of.
The most fruitful areas, he reckons, are information and healthcare technology, diagnostics, and specialist-drug companies. “In the long term, the stockmarket is rational and will reward the companies that generate higher levels of growth and cash generation.”
Investors, as Major says, “are paying less for growth in the healthcare sector than anywhere else. Healthcare has never looked cheaper
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