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It’s a good time to be invested in healthcare. This area has historically outperformed during previous market downturns and evidence suggests it will do so again.
The sector is already just one of 12 – out of 50 – that has delivered positive returns over what has been a very challenging year, according to Morningstar data*.
By way of comparison, the popular UK All Companies sector is at -13.16% over the same 12-month period, IA Sterling Corporate Bond is at -21.13%, while IA UK Smaller Companies is at -29.73%.
Here we look at why healthcare has been doing so well, consider its prospects in a possible recession, and highlight funds that invest in healthcare stocks.
Healthcare is an umbrella term covering a wide variety of areas. These include everything from global pharmaceutical giants to smaller, innovative biotechnology names.
These various industries won’t move in tandem, according to Andy Acker, who is responsible for the global life sciences and biotechnology strategies at Janus Henderson Investors.
“Each is impacted differently by rising [interest] rates, labour costs and other macroeconomic trends,” he said. “Investors who keep these dynamics in mind may be able to maximise healthcare’s defensive nature, while also positioning for growth when the next economic expansion begins.”
All these sub-sectors of healthcare play important roles in diagnosing conditions, developing treatments for diseases, and giving people a generally better quality of life.
Andy pointed out that healthcare has historically outperformed in market downturns, which he believes helps explain its current resilience.
“That the healthcare sector is proving resilient is not surprising,” he said. “Across five downturns in global equities since 2000, the sector’s downside capture ratio has averaged just 51%.”
This ratio measures an asset’s performance in down markets. It’s calculated by taking the asset’s return during periods of negative benchmark performance and dividing it by the benchmark return.
He also noted that pharmaceuticals was one of the more defensive subsectors in this area as demand for medicines tends to be inelastic.
“With strong balance sheets and high free cash flows, large-cap pharma companies are also less sensitive to rising rates – and with many levers to pull to reduce expenses, these firms are less susceptible to inflationary pressures,” he said.
Certain characteristics are going to become very important if we enter a recession, according to Alistair Wittet, co-manager of Comgest Growth Europe ex-UK.
“The first is going to be the defensiveness of the company’s revenue streams,” he said. “There are, of course, revenue streams out there which are far more defensive than others.”
He therefore believes healthcare could be well-placed should a recession hit. “Healthcare spending in US records has never fallen – and that includes multiple financial crises, such as Covid-19,” he said. “So, we think that is a space that will continue to be defensive.”
Of course, it’s also worth looking at the longer-term potential of healthcare – and not just the ways in which it will, hopefully, prevail in a recession.
In a recent webcast, he highlighted demographics as a major positive growth driver for the sector, and pointed out another key theme was making healthcare delivery more efficient. “We need innovation to make healthcare more cost effective,” he said.
He explained the way Polar Capital thinks about investing in healthcare, is through products and services that keep patients out of hospital – or gets them back home as quickly as possible.
More broadly, Gareth argued that healthcare fundamentals remained strong, while valuations were attractive and offered the potential for significant returns. He has identified six important themes. These were healthcare delivery disruption; innovation; consolidation; emerging markets; outsourcing; and prevention.
“Consolidation is a major theme as healthcare is the most fragmented industry out there,” he said. “We expect to see continued M&A as the industry becomes more efficient.”
The move towards outsourcing is seen by Gareth as “super important” in the industry’s journey to become more efficient. “Outsourcing was critical in the development of the Covid vaccines,” he said. “With prevention, the pandemic illustrated the power of vaccines and how important they are in healthcare.”
The global opportunity for increased healthcare spending around the world is another driver for the sector that will be of interest to potential investors. Gareth said that the United States and Switzerland were spending the most on healthcare per capita, but that there was a need for them to become more efficient and productive.
The emerging markets, meanwhile, have huge opportunities, particularly given the fact that relatively little is spent in these areas in comparison to developed countries.
Gareth believes large cap and mega cap healthcare names are really attractive. “The fundamentals are good,” he said. “In stagflationary environments these types of stocks shine.”
Even in small and mid-cap names, which have been hit very hard recently and require careful stock picking, there are opportunities. “We think they look very attractive on a number of metrics, so we’re optimistic about healthcare in terms of relative performance and the potential for the sector to do very well over the next (few) years,” he said.
Much of this optimism is being driven by changes in US policy. “We’re hoping we’ll now see a number of years where policy is not a major headwind and that could lead to an expansion of valuations in the healthcare sector, potentially being a new bull market,” he added.
While specialist healthcare funds obviously give the purest access to this sector, more diversified exposure can be achieved by opting for funds investing in a broader variety of industries.
For example, healthcare is the largest sector allocation in the Artemis Positive Future fund.
Its largest holdings include Cochlear, a global leader in implantable hearing solutions, and Diasorin, an Italian multinational biotechnology company**.
At 35%, healthcare is also the largest sector allocation in the European Opportunities Trust**. Manager Alexander Darwall told us about one holding – Novo Nordisk – and how its diabetes drug is now also being used for weight loss, in this recent podcast:
*Source: Morningstar, total returns in sterling, one year to 10 October 20222
**Source: fund factsheet, 31 August 2022
Photo by CDC on Unsplash