Look beyond coronavirus for long-term growth in healthcare

As the world emerges from the coronavirus pandemic it is likely that there will be increased political support for public sector healthcare investment, which should help drive earnings and innovation. And healthcare companies tend not to have cyclical characteristics so can be an attractive area for investment in times of such uncertainty.

Edward Park, deputy chief investment officer at wealth manager Brooks Macdonald, says that healthcare remains one of his preferred equity themes. “Our longer-term view is that the post-coronavirus world will still be challenged by low growth and interest rates, as it was before the virus took hold," he explains. "As a result, we expect growth sectors such as healthcare to continue their relative strength."

Major healthcare indices are also trading at lower valuations than broader equity indices. Mr Park points out that the MSCI World Pharmaceuticals, Biotechnology and Life Sciences index is currently trading at 16.5 times expected earnings for the next 12 months, while the broader MSCI World index has a 12-month price to earnings ratio of 19.5 times.      

Ageing populations, people in developing countries adopting diets more like those of people in developed countries, and a greater desire to spend more money on health should create more demand for the products and services of healthcare companies. Increased investment in health infrastructure also makes it an attractive area for investors. 

Biotech in particular is an area to watch as these types of companies focus on areas such as gene therapy and oncology, and if you invest in a successful drug developer you can make a very good return. Biotech companies have generally done very well so far this year because some of them are trying to develop coronavirus vaccines. Exciting opportunities can be found in the emerging biotech space, where companies are developing novel drugs for rare diseases and types of cancer.  

However, biotech stocks can be extremely volatile and some investors are concerned that healthcare company valuations are high, which may be the case with some biotech stocks.

Healthcare is also very sensitive to political and regulatory developments. Most of the stocks held by healthcare funds are US-listed companies, so if the US healthcare system changes – for example following a change in government after the election in November – it could have a detrimental effect on the profits of companies in this sector. However this is not thought to be a big risk as Democrat candidate Joe Biden is not currently proposing any massive changes. 

“There is no doubt that – in aggregate – healthcare and biotech has proved to be a fantastic area to have been invested in over the past two decades,” says Jason Hollands, managing director at Tilney. “However, a balanced assessment also needs to appreciate the risk of mounting pressure by governments to exert greater control on pricing, including in the lucrative US market. The costs of tackling Covid-19 globally are only likely to heighten the case for increased interference in drug pricing.”

Healthcare is also a significant sector in many developed markets and, for example, represents 15 per cent of the S&P 500 index and 14 per cent of MSCI UK index. This means that many investors have exposure to major healthcare stocks via tracker and active funds – even if they do not hold a specialist healthcare fund. For example, Scottish Mortgage Investment Trust (SMT) had 6.3 per cent of its assets in Illumina (US:ILMN) a pioneer in DNA sequencing, at the end of April. And at the end of March it had almost 14.4 per cent in healthcare companies overall.

Passive funds for healthcare exposure

There are a number of healthcare-focused exchange traded funds (ETFs) listed on UK markets. These passive funds typically have much lower charges than active funds, and because they track entire indices don't incur the risk of a manager making a poor investment decision. But before investing in a healthcare ETF, check its assets under management. The larger this figure is, the more money investors have put into the ETF, which suggests a broad level of confidence in the product.

Although the number of ETFs available to UK investors is increasing, there are a number of active funds that have significantly outperformed their benchmarks over the longer term. Healthcare stocks can also be volatile and higher-risk, in particular biotech companies. But if the manager of an active fund picks the right stocks it could make strong returns. Adrian Lowcock, head of personal investing at broker Willis Owen, argues: “Active management is likely to be the best approach as there are many companies in the research and development phase that might not survive to profitability. Detailed research is essential.”  

However, if you wish to benefit from the cost benefits of passive investing, you can get broad exposure to healthcare companies via iShares S&P 500 Health Care Sector UCITS ETF (IHCU) because many fast-growing healthcare companies are listed in the US. It holds 61 healthcare stocks included in the S&P 500 and it has an ongoing charge of 0.15 per cent. 

Xtrackers MSCI World Health Care UCITS ETF (XDWH) tracks MSCI World Health Care Index, which includes 143 healthcare stocks. At the end of May, this index had a 68 per cent weighting to the US, 9 per cent to Switzerland and 7 per cent to Japan.

Some ETFs track specific types of healthcare companies, but tend to have higher fees. For example, iShares Healthcare Innovation UCITS ETF (DRDR) tracks iSTOXX FactSet Breakthrough Healthcare Index, which is composed of 116 companies in developed and emerging markets that focus on pushing the boundaries in medical treatment and technology. This index has performed well recently.

iShares Ageing Population UCITS ETF (AGES), meanwhile, tracks an index of developed and emerging market companies, which are generating significant revenues from the growing needs of the world’s ageing population. So it offers exposure to healthcare companies.

For exposure to biotech stocks, options include Invesco NASDAQ Biotech UCITS ETF (SBIO). It tracks an index made up of 208 biotechnology and pharmaceuticals companies listed on the Nasdaq exchange and the fund is up over 20 per cent in the year to date.

Active funds for healthcare exposure

Over longer time frames, investment trusts focused on healthcare have tended to make stronger returns than open-ended funds focused on this area. This may be because they have the option to use gearing – take on debt to invest more than their assets – which can amplify positive returns. Their closed-ended structure also means that they can invest in unquoted companies, which may have greater growth potential than listed equities. However, these factors mean that healthcare investment trust returns can be more volatile than those of open-ended funds.  

For exposure to the full spread of the healthcare sector, Mr Hollands suggests Worldwide Healthcare Trust (WWH). It invests in biotech, pharmaceutical, medical device technologies, life science tools and healthcare services companies. Since its launch in 1995 it has made an annualised return of 15.9 per cent. 

Mr Lowcock suggests AXA Framlington Health (GB00B6WZJX05), which focuses on large-cap pharmaceutical stocks, and whose largest holdings include Merck (US:MRK) and AstraZeneca (AZN). Its manager, Dani Saurymper, started to run it in 2015 and has longer experience as an analyst covering healthcare stocks. 

Polar Capital Healthcare Opportunities' (IE00B3NLDF60) managers take a long-term view on companies across the healthcare industry and typically hold 40 to 45 stocks. In particular, they try to get exposure to companies driving innovation, and transforming to meet changing industry dynamics by using data and analytics to improve efficiency.

For exposure to biotech companies, Biotech Growth Trust (BIOG) is run by the same team as Worldwide Healthcare Trust. Its managers hope to take advantage of increasing opportunities in China, and Orbimed, the company that runs it, has two analysts on the ground there. This trust had underperformed for a number of years, but has done very well over the past year.

International Biotechnology Trust (IBT), meanwhile, invests in large, mid and small-cap companies, primarily quoted on stock exchanges in North America. But it also had 13 per cent of its assets in unquoted companies at the end of May via a private equity fund, which its managers run too.