Join our community of smart investors

Get a boost from lucrative health technology

Several funds are seeking to profit from technology that is designed to meet healthcare challenges
Get a boost from lucrative health technology
  • Revenue purity and growth important for healthcare ETFs
  • How to value pre-revenue companies at the vanguard

With over 7.7bn people on the planet, the idea of a population crisis won’t shock anybody, but the underlying demographic problem is equally stark. Many people will see falling birth rates in large parts of the world (not just in the west and democratic Asia, but also in Russia and China) as being positive. Still, that implies a series of crunch points where there aren’t enough younger members in many societies to work, pay taxes and take care of the increasing proportion of elderly.

Technology therefore must provide many of the productivity and development solutions the world needs, especially in healthcare. Automation and robotics, supply chain management and smart devices to manage patient needs could ease the pressure on human labour. Health tech, therefore, is an area of the economy with important structural drivers, but investors must still do their homework.

Health tech’s a great theme, but all trends need a health warning

Thematic investing has its drawbacks. Concentrating holdings and moving away from market weights is what you must do to generate alpha, but there will be times when the element of returns that are due to deviation from the benchmark aren’t positive. That’s an occupational hazard of having conviction, but there are other risks that should offer an additional return premium, such as cases where funds hold a lot of smaller companies with less liquid (harder to buy and sell) shares.

In addition, expertise in picking the best companies to take advantage of the health tech trend comes at a price. Sector specialist funds are charging their own premium of, in some cases, more than a whole percentage point above what you’d pay for a global tracker exchange traded fund (ETF). That’s not to say they aren’t worth it, but investors should be mindful of both basic and performance fee structures when choosing funds.

With these important points made, there is plenty to recommend health tech as a theme for satellite holdings in a diversified portfolio.

Many exciting trends are converging in health tech

Healthcare is about even more than the science of medicine. Other themes such as the Internet of Things (IoT) will play a part in meeting future needs. An example is Vocera (US:VCRA), which manufactures smart communications software for medical professionals and the devices used to help care for patients.

“As more and more devices are becoming digitized, they are able to be connected and integrated to one another,” says Nina Deka, senior research analyst at ROBO Global.

Vocera’s software and devices are integrated with over 140 medical devices and healthcare providers use Vocera’s hands-free wearable kit to communicate with one another and receive alerts from devices connected to patients. Bedside alarms are nothing new, but smart alerts are aiding efficient and pre-emptive care.

“For example, if a patient with a risk of falling is trying to get out of a smart bed, the lowering of the bed rail will alert the patient’s nurse that they need to help the patient,” explains Deka.

Building patient profiles via devices and huge amounts of data creates a touch point with the cyber security tech trend. “With time and investment, healthcare should be able to catch up with other sectors, like financial services, to help ensure data safety.” Deka posits that further adoption of blockchain could also provide a solution, because it can set up trusted sources of information.

This last point is interesting because healthcare applications have been listed by blockchain protocol designers such as the Cardano project. “There is an enormous opportunity for blockchain to drive efficiency and transparency in healthcare,” continues Deka. “We are already seeing examples of supply chain management with companies like IBM, which can offer a way to track drugs, like Covid vaccines from the manufacturing line all the way to the patient who receives a dose.”

Such systems help with transparency, safety, and authenticity; and also supply chain management (a crucial issue we are seeing as the world moves from 'just in time' but wants a better option than 'just in case' when it comes to matching needs with scarce resources).

Blockchain is also being used for credentialling physicians and in the future could provide an opportunity for patients to control their own medical records and grant permissions. Such innovations could save billions on sprawling but centralised IT projects that are a major cyber risk and point of failure in supply chain and care management for organisations such as the NHS.

Specialist funds have emerged

Several funds now target the confluence of healthcare and related growth themes. Investment trusts in the Association of Investment Companies (AIC) healthcare sector include funds such as BB Healthcare (BBH) and Worldwide Healthcare Trust (WWH) that have a high proportion of holdings in large pharmaceutical companies. Polar Capital Global Healthcare Trust (PCGH) also has roughly 40 per cent of assets invested in its top 10 holdings and its sector weightings are about a fifth in healthcare equipment and a fifth in pharma.  

There are also trusts focusing mainly on biotech such Biotech Growth (BIOG), International Biotechnology (IBT), RTW Venture Ltd (RTW) and Syncona (SYNC). Early-stage life sciences technology is risky (investee companies burn through cash and there is a real chance that clinical trials fail), but a diversified portfolio gives ordinary investors a more straightforward play on a number of companies at various stages of business maturity. Furthermore, the closed-end fund structure affords liquid exposure, which is helpful given some underlying holdings may be illiquid.

For diversification across several opportunities in healthcare technology including robotics, communicationstechnology, vaccine sciences, genomics (the study of gene sequences which couldhelp fight disease), diagnostics and data analytics, there are other options, such as L&G Healthcare Breakthrough UCITS ETF (DOCG). Another product offering in the space, the HAN-GINS Indxx Healthcare Megatrend Equal Weight UCITS ETF (WELL), comes from HAN ETF and GinsGlobal index funds.

One great advantage of ETFs is their lower cost. The total expense ratio of WELL is 59 basis points (bps), or 0.59 per cent. The costs for DOCG are currently 49bps.

WELL and DOCG are examples of the new generation of semi-active ETFs that benefit from a lot of expert oversight of the indices they track. The size of companies is important for an open-ended fund structure, due to liquidity, but the selection criteria still prioritise innovation and something Deka describes as “earnings purity”. The scoring system for the index tracked by DOCG requires a high proportion of revenues to be derived from healthcare, with technological leadership and disruptive developments also dictating what makes the cut.

WELL is an equal-weight ETF that has 104 holdings with a minimum market capitalisation of $500m and an average daily turnover of over $2m. A word of warning is that past average daily turnovers might not mean much if markets suffered a major liquidity event. But, on the assumption investors are looking at health tech as a satellite holding for the long term, this is the type of potential high-growth investment where a bit of added risk in exceptional circumstances can be tolerated as part of a balanced portfolio strategy.

The companies tracked include life sciences companies and also robotics, medical devices, and nanotechnology, so it is a diversified play on the trend and the equal-weight structure prevents over-concentration in a few hyped companies. The largest positions therefore reflect shares that have done well since the index was last rebalanced. In the case of WELL, a genome-sequencing business Intellia Therapeutics (US:NTLA) had shot ahead by the end of September.

Looking at data for this one company, the benefits of a diversified investing strategy for the sector are clear. Although NTLA's shares had a great run over the summer, FactSet data shows analysts’ consensus estimates for full-year 2021 and full-year 2022 earnings have been revised downwards. Furthermore, forecast sales for the end of 2021 are below actual figures for full-year 2019. Without knowing much about the company, that would be cause to question a growth stock.

Sales is the crucial factor in assessing many of the companies in this space. In the case of DOCG, 28.7 per cent of the portfolio holdings have negative earnings. It’s not uncommon for companies at the dawn of growth opportunities to be pre-profit, but the path to profitability is vital, which means revenue growth whether through approved products or from partnerships.

Enterprise value (EV, the sum of market capitalisation and net debt) divided by sales is the best metric for judging health tech companies. On this basis, the DOCG portfolio was cheaper at the end of Q3 2021 (6.4 times) than it was a year earlier (7 times), says Deka. In terms of annualised sales growth, the portfolio median was 16 per cent at Q3 and the long-term average expected is 12.9 per cent.

Some holdings will drift in and out of favour, but there is a long runway for growth. Deka argues that important benefits of diversification are being “present when a sub-sector is hot and de-risking sub-sectors that are in the back seat”.

On top of that another plus point is the ability to target more companies in fragmented industries. “A diverse portfolio helps capture all companies that are derivative plays of the neat innovation happening in healthcare,” says Deka.  In other words, that means investing in lucrative areas along the healthcare value chain, which involves a lot of exciting companies.