Why this defensive sector is primed for growth

The healthcare sector has long held some natural advantages. The wealthiest nations are getting older, creating more demand for its products and services. At the same time, emerging markets have a growing middle class keen to access more effective treatments. More recently, scientific developments and the application of AI have created a new growth industry within healthcare.

This is a compelling backdrop. Yet the recent performance of the healthcare sector has been disappointing. The MSCI World Health Care index is down 5.6% for the year to date, against a rise of 8.3% in the MSCI World Index*.

This weakness is more surprising given healthcare’s cherished reputation as a defensive option. It is, in theory, a sector that can perform in all economic conditions because people always need medicine or treatment, but that hasn’t happened in practice.

Why the recent weakness in healthcare?

Part of this weakness may be a legacy from the pandemic. The crisis generated vast government spending on healthcare, reaching a new high of $9 trillion in 2020**. This is equivalent to 11% of global GDP**. The UK government alone spent a total of £213.4bn on healthcare in 2020***. This has inevitably dipped as the immediate threat of the pandemic has ebbed.

Goldman Sachs recently suggested that the sector had also been laid low by regulatory concerns and fears over economic growth. Certainly, the attention of both investors and governments has been elsewhere. The US Inflation Reduction Act, for example, had some healthcare initiatives within it, but focused more on renewable energy and infrastructure. For their part, investors have been resolutely focused on the large technology companies.

The sector may also be anticipating the US Presidential election next year. The US market remains the largest for healthcare, spending 18.8% of its GDP there****. However, it tends to be a political football between Democrats and Republicans, and with the Republicans ahead in early polls, there is a concern that spending may drop.

Longer term prospects for the sector

However, there is no doubt that the longer-term tailwinds for the healthcare sector remain strong. The demographic argument is sound. The majority of developed economies have ageing populations and are showing greater demand for healthcare. A recent OECD report showed that 35% of the population of OECD countries had a longstanding illness or health problem in 2019*****. Countries have generally been poor at addressing chronic disease – in the same year, OECD health systems spent less than 3% of total health expenditure on prevention*****.

Equally, diseases such as obesity continue to create demand for healthcare products. Danish multi-national Novo Nordisk has a vast diabetes business, but also, more recently an effective weight loss drug, Wegovy. The group’s share price is up 76% over the past 12 months as demand has rocketed^.

Against this backdrop, the demand side remains substantially in tact.

Mark Nichols, co-manager of the Jupiter European fund, tells us more about Novo Nordisk’s success

Supply factors to consider

There are also exciting things happening on the supply side. Andy Acker, portfolio manager at Janus Henderson, says: “There is a wave of innovation where we’re seeing this revolution in biology that’s driving so many new products. This year we think will be a record year for new products; as many as 80 could be coming to the market. And this is driving a whole new product cycle in healthcare that we think could drive growth, not just for the next few years, but for the next decade or more.”

This product innovation spans a number of sectors. Andy points to developments in autoimmune and inflammatory disorders: “researchers have continued to identify new biomarker targets or mechanisms of action with the potential to further improve the standard of care for patients.”

The Baillie Gifford Global Discovery fund has 44% in healthcare^^. Manager Douglas Brodie has a degree in BSc in Molecular Biology & Biochemistry and has been focused on developments in genomics. “We’ve got companies that have the ability to write, read, edit DNA,” he says. The fund’s largest holding is in therapeutics group Alnylam Pharmaceuticals^^, which is focused on developing a pipeline of RNAi drugs in the areas of genetic medicines, hepatic infectious, cardio-metabolic, and central nervous system diseases.

Artificial intelligence is also increasingly widely used in healthcare, particularly in diagnostics. Douglas holds Exact Sciences^^, which is focused on early cancer detection and monitoring. This is a fast-moving area and may turn out to be one of the most compelling AI opportunities.

Where to invest in healthcare today

There are a number of options for investing in healthcare. Funds such as the Baillie Gifford Global Discovery fund will give exposure to healthcare innovation, alongside other areas of technology innovation. Generalised healthcare vehicles, such as the Polar Capital Global Healthcare Trust, will give blended exposure to healthcare names. Pharmaceuticals is the highest weighting, at 31%, but this still represents a 10% underweight versus the benchmark^^. The trust also has a 20% weight in biotechnology, plus exposure to healthcare equipment, facilities and suppliers^^.

Another option is a specialist biotechnology fund, such as AXA Framlington Biotech. Biotechnology is inevitably higher risk, but it is at the cutting edge of drug research. The fund is significantly invested in mature biotechnology businesses, such as Regeneron Pharmaceuticals or Biogen^^, but biotechnology is inevitably a bouncy ride.

Those investors looking for exposure to the sector without putting all their eggs in one basket might consider European Opportunities Trust with 37% in healthcare and top holding Novo Nordisk and bioMérieux, a French biotechnology company^^. The WS Montanaro Better World fund identified healthcare as one of the six impact ‘themes’ of the fund and currently holds a third of the portfolio in healthcare^^.

Healthcare has been a tough place to be invested over the past 12 months, but investors may rediscover its longer-term strengths as economic confidence improves. Equally, any volatility surrounding the US election may provide an opportunity to buy in more cheaply.

*Source: MSCI World Health Care Index factsheet, October 2023

**Source: World Health Organization, December 2022

***Source: Office for National Statistics, May 2022

****Source: The World Bank, April 2023

*****Source: OECD, February 2023

^Source: Google Finance, 7 November 2022 to 7 November 2023

^^Source: fund factsheet, September 2023

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