When we talk about fat returns, we usually mean it metaphorically. But a recent report from Bank of America Merrill Lynch considers a more literal interpretation. It argues that increasing efforts to tackle obesity will form a whole new area of focus for investors. The report, called "Globesity - The Global Fight Against Obesity", lists 50 companies that could benefit, predicting that efforts to reduce obesity are a mega trend which will go on for 25 to 50 years.
Among the flabby fifty are UK healthcare products group Smith & Nephew and food producer Unilever. But the vast majority of them are listed overseas. That might not stop you buying their shares, if you're happy to deal with dividends in foreign currencies and dual taxation issues. But a quicker, easier and more convenient way to gain exposure to the obesity theme is via a healthcare fund - and there's no shortage of options.
Demand drivers
More people are going to consume more drugs over the coming decades as life expectancy grows and certain types of disease become more prevalent. This will be particularly evident in emerging markets where growing wealth means increasing numbers of people will have access to healthcare. Their adoption of western lifestyles and diets means they will also suffer from diseases prevalent in developed countries such as diabetes, which is often related to obesity. Diabetes is already a considerable problem in India, while HIV and Aids are growing problems in China. With populations in excess of 1bn people potentially big markets are developing in these and other emerging markets.
Drug spend per head is low in China, India, Brazil, Russia, Korea, Turkey and Mexico, which in total only contribute 10 per cent to total world drug spending. But this looks set to change. Meanwhile, reforms to healthcare in the US - recently upheld in the US Supreme Court - should also have a long-term positive impact, with 30m more Americans having access to healthcare from 2014.
Risks
It isn't all plain sailing for the global healthcare industry. Intellectual property rights in the developing world are not always as robust, so healthcare companies don't necessarily have the same pricing power as in developed countries. Countries such as Israel, India, Brazil and South Africa have thriving generics industries; in India particularly there is widespread domestic competition so it is very difficult for foreign companies to establish themselves.
In the west, government budgets are under pressure and drugs bills are an easy target. More insured Americans should be a benefit, but drug suppliers may also be forced to drive down costs and therefore revenues. Despite the increasing health consumption of emerging markets, the US is still by far the biggest healthcare market.
Different strokes
Healthcare companies fall into two main areas. There are large multinational pharmaceutical companies which grow slowly but pay juicy dividends. UK examples of this genre are GlaxoSmithKline and AstraZeneca. Biotechnology and drug discovery companies tend to be smaller and focus on research and development of new drugs. If these are successful the companies can do very well - usually via licensing or takeover deals - but they can also draw a blank and run out of money. They're a high-risk, high-return option.
One thing they have in common is that they're cheap. Healthcare companies are near their lowest valuation levels in 30 years, according to Sam Isaly of OrbiMed Healthcare Fund Management, and the low price earnings ratio multiples may provide significant downside protection. He says beyond 2012 growth could increase. "Valuations across the healthcare sector have declined to historical lows after a nearly 10 year period of underperformance," he says. "But performance and valuation differential provides potential opportunity to earn near-term returns across a variety of long positions."
Larger health care companies can also be more insulated from an economic downturn as they tend to be strong, cash rich companies. Biotech companies - allowing for survivorship bias - have delivered above market earnings growth and strong cash flow generation relative to larger companies.
"Large biotech companies offer predictable and stable earnings growth insulated from austerity," says David Pinniger, co-manager of International Biotechnology Trust, adding that the consistent theme of high value pharma-biotech mergers and acquisitions is generating strong returns for investors. For big pharma companies, it can be more cost-effective simply to acquire new products than develop them.
As a result, the biotechnology sector has significantly outperformed the broader market over the long-term, as evidenced by the strong growth of the Nasdaq Biotechnology index. Since 1993 it has returned 550 per cent against 330 per cent for the broader S&P 500. The biotech sector is also coming back into the spotlight as a number of major new biotech drugs emerge, adds Mr Pinniger.
While biotech companies offer great growth upside this comes at the price of great volatility. In falling markets these shares tend to fall further than the broader market. If a company's drug is unsuccessful or not approved by the US Food and Drug Administration, it can have a devastating affect on the company.
Diversifying such stock-specific risk is important, and to do that, you have to head overseas - particularly to the US - as the biotech sector in the UK is small, both in number of companies and their average size. That's another reason to opt for a fund rather than try to pick stocks yourself.
Choosing a fund
Healthcare funds are a concentrated sector, which increases risk potential so ideally such a fund should only account for a small portion of your portfolio. Simon Webster, managing director of independent financial adviser Facts & Figures suggests a maximum exposure of 5 per cent. He adds that if you are going to allocate to specialist funds you should also have a larger portfolio of at least £50,000, a high- risk appetite and a long-term time horizon.
Watch out for overlap with your existing equity holdings. A healthcare fund that includes large-cap pharmaceutical stocks will almost certainly contain Glaxo or Astra - shares that are also widely owned by private investors - along with European ones such as Novartis and Bayer, which are also on our buy list.
