The fund manager’s view
James Buckley, fund manager, the Castlefield Sustainable European fund
Within the healthcare sector, investors have been firmly focused on a breakthrough in tackling obesity resulting from recent drug launches by Novo Nordisk and Eli Lilly. Indeed, the near 60% rise in Denmark’s Novo Nordisk over the past 12 months means it is now the largest listed company in Europe. This share price performance has been driven by strong demand for its high-profile weight loss drug, Wegovy, and diabetes treatment, Ozempic, which have evolved from Novo Nordisk’s longstanding leadership in diabetes medication.
These drugs, together with Eli Lilly’s diabetes medication, Mounjaro, are at the forefront of the search for a medical solution to the obesity epidemic, mimicking appetite suppressing hormones. Given that the largest global healthcare market, the US, has some 100 million obese people, (defined as BMI over 30), this enthusiasm is understandable. However, there are other significant breakthroughs being made in the healthcare sector, notably in areas such as oncology and dementia.
While Eli Lilly and Novo Nordisk traded on significant premiums to the broader market at forward PE multiples of 56x and 38x, respectively, other large-cap healthcare stocks are on much more modest ratings.
These include names such as France’s Sanofi, on 12x, and Merck of the US on 15x, both of which have significant pipeline potential in terms of new drug launches in phase three development. Sanofi has a blockbuster drug in anti-inflammatory treatment, Dupixent, which continues to be adapted for new treatment areas and grew sales 25% year on year during Q1 to almost €3bn (£2.55bn).
Healthcare is known as a defensive sector, offering strong cashflows and progressive dividend payouts, with Sanofi yielding over 4%. We believe valuations are attractive in selected names and the sector also scores highly on ESG grounds, with access to healthcare being an essential societal need. As such healthcare names feature prominently in our portfolios.
The economist’s view
Joaquin Thul, economist, EFG Asset Management
The healthcare sector will likely be affected in the short term by the next US presidential election. The sector tends to underperform the S&P 500 index in election years as it becomes a political battleground. Healthcare has underperformed in five of the past eight election years by an average of 10%, explaining the underperformance of healthcare stocks by almost 3% year to date.
Both Democrats and Republicans will try to impose changes. Biden has pledged to maintain, and potentially expand, the Affordable Care Act (ACA). He also intends to cap drug costs for older citizens and expand the number of drugs subject to Medicare price controls.
See also: Four views: Mapping the frontier
Republicans aim to repeal the ACA, replacing it with block grants to the states, and relaxing rules regarding funding of pre-existing conditions. Trump intends to cap funding for Medicaid and cut overall funding by more than $1trn (£0.8trn) over 10 years. However, given projections of a split Congress, it is unlikely either candidate will be able to bring changes to the sector. This could be beneficial for the industry.
Companies have cited higher costs due to inflation and wage increases which has hurt margins. However, earnings are expected to recover, due to stable revenue growth of around 6%.
Despite the short-term challenges, demographic trends worldwide support the long-term prospects. Countries are expected to experience demographic headwinds in the coming years, which will constrain growth but potentially increase healthcare spending.
US healthcare spending represents more than 16% of GDP, the highest among OECD countries. This is expected to increase. US spending on major healthcare programmes, which currently represents over 40% of total mandatory outlays, is expected to increase to 46% by 2034.
Overall, despite short-term headwinds related to the presidential election, we remain supportive of the outlook for healthcare in the long term.
The fund selector’s view
Paul Hookway, senior fund analyst, SG Kleinwort Hambros
Healthcare names such as GlaxoSmithKline, Merck and Roche need to demonstrate their ability to manage their existing range, in order to maximise return on development costs and, second, add new drugs to drive future performance. The former sets in place the platform on which the latter will deliver maximum returns.
While good returns can be delivered from existing platforms, it is hard to outperform global equity markets by relying on this factor alone. New drug discoveries are required to deliver significant uplifts in earnings and market valuations.
For investors, this creates a problem of how to identify where the next blockbuster drug will come from. Indeed the latest, for weight loss, originated from research focused on diabetes treatment, notably Wegovy from Novo Nordisk and Tirzepatide from Eli Lilly, resulting in significant re-ratings for both.
To have any chance of capturing some of this extra value, a well-resourced team with a strong medical background is a prerequisite, together with a diversified portfolio, maximising the potential to capture the upside on offer from the development of new drugs.
See also: Aegon’s McPartlin: Three stocks driving the paradigm shift in healthcare
The other tack would be to identify companies with exposure to large addressable markets that are as yet underpenetrated, offering significant growth potential over many years.
Apart from diabetes and obesity, areas of intense research include dementia, motor neurone disease and Parkinson’s, to name but a few.
During the past five years, the global healthcare sector has lagged behind global equity markets, though a handful have broadly matched its performance. This does make it hard to allocate to healthcare in a multi-asset portfolio unless it is based on global thematic trends, when it could form a useful diversifier within
the portfolio.
The wealth manager’s view
Alex Hunter, global equity analyst, Sarasin & Partners
The clinical sphere has rarely captured the public imagination as the class of medicines known as GLP-1s. While the full scope of the GLP-1 market is uncertain, current consensus is for the whole market in GLP-1s to be in the region of over $100bn a year by early next decade.
Eli Lilly and Novo Nordisk have established themselves as the market leaders, thanks to the quality of their current products and their pipelines for more sophisticated GLP-1-based approaches. Room for advancements in metabolic medicines exist in the areas of more convenient dosing intervals, developing an oral drug and mitigating GLP-1-driven muscle loss while improving side effects.
Our preferred exposure to GLP-1s remains Eli Lilly, which has outperformed Novo Nordisk over the past year, although Novo could benefit from several data releases, including Oral Semaglutide potentially at some point in Q2.
GLP-1s have had far reaching implications for the healthcare sector. Bearing the brunt of this are companies that focus on conditions associated with being overweight or obese, particularly diabetes and heart conditions. Others at risk include companies linked to treatments including joint replacements, dialysis, sleep apnoea relief and weight-management products. The extent of the impact on these areas remains uncertain.
However, for the biggest thematic driver of healthcare, the steady but seismic ageing of western demographics, demand will not change. The amount of over-60s in OECD countries is set to more than double between now and 2050 while government debt appears to be remorselessly increasing, necessitating greater healthcare innovation and efficiency.
GLP-1s have certainly could have a role in extending health span (the portion of lifespan with full health).
However, while a thinner population can enjoy better health for longer, they will inevitably require other medical treatments as they age. For example, fewer cases of diabetes, heart disease and hypertension could lead to more demand for cancer and Alzheimer’s treatment, and care at a later stage in life.
This article first appeared in the June issue of Portfolio Adviser magazine
