Healthcare fund managers caution against getting caught up in Covid-19 vaccine hype

The news flow coming out of Gilead Sciences regarding its promising vaccine for Covid-19 was a rollercoaster ride in April. The stock had rallied 16% early in the month when patients treated with its antiviral drug remdesivir were reported to show a rapid recovery in respiratory and fever symptoms. Several weeks later the World Health Organization accidentally published a draft assessment of the first trials on its website revealing results had been disappointing. The stock fell 9% on the news. By the end of the month it was leading a global market rally as it revealed data from a US trial had been positive.

Healthcare and biotech funds have the chunkiest weightings to companies on the frontline of the coronavirus pandemic. But the managers of these funds are keeping cool heads as the stocks outperform.

Of the eight funds in the Investment Association (IA) universe that hold Gilead Sciences, the ones with the weightiest allocations all focus on the sector. The Gam Multistock Health Innovation Equity, Pictet Biotech and Axa Framlington Biotech funds all hold more than 6%, according to FE Fundinfo. The Candriam Equities Biotechnology fund holds 5.6%.

Healthcare and biotech fund performance Q1 2020

Source: FE Fundinfo

The remaining investors are generalist funds with much smaller weightings of between 1.2% and 1.8%. In the closed-ended sector, the International Biotechnology Trust holds 4.2% and the Biotech Growth Trust holds 3.5%.

Pictet Biotech manager Lydia Haueter, who is also a product specialist on the Pictet Healthcare Fund, names Gilead and Regeneron among the portfolio holdings she thinks will receive the most headlines in the near term for their work on Covid-19 treatments.

Regeneron is currently trialling an ‘antibody cocktail’ that would be a prophylactic for people who have not yet been infected or a treatment for patients that have contracted the virus. The $1.5bn Pictet Biotech Fund has a 6.6% weighing in Regeneron, as does the £371.8m Axa Framlington Biotech Fund. These are largest allocations in the IA universe, according to FE Fundinfo. The only generalist equity funds that hold the stock in their top-10 are the Natixis Loomis Sayles US Equity Leaders and Harris Associates US Equity funds, at 3.7% and 3.1%, respectively.

The limited commercial opportunity from a Covid-19 treatment

However, healthcare and biotech specialists are cautious on getting caught up in a sentiment-driven rally. “In terms of actual contribution to discounted cashflow, a Covid treatment will likely not be that substantial. I don’t think they will charge a huge price for such a treatment,” says Haueter. “In the case of Gilead, and also Regeneron, we’ve actually taken some profit. Right now, we think it’s probably not a good reflection of the economic reality underlying the stock.”

OrbiMed partner Trevor Polischuk, who is a portfolio manager on the £1.8bn Worldwide Healthcare Trust, offers a similar assessment. “While the industry has been really impressive in stepping up their collective efforts to fight this global pandemic, the overall commercial opportunity for most of the companies is small, not just because of the potential price point but because these are not necessarily recurring revenues.”

Fidelity Healthcare Fund manager Alex Gold has benefited from Regeneron and Gilead exposure but points out that diagnostics and some medical equipment suppliers have also proved resilient during the sell-off.

ThermoFisher, Danaher, Abbott and Roche have developed diagnostic tests for Covid-19, while ventilator manufacturers such as Getinge and Draegerwerk have seen an increase in demand.

Gold’s £812.5m fund had been under-weight pharmaceuticals and biotech going into the coronavirus pandemic and was overweight medical devices, which had been a strong contributor to performance up until the crisis.

“While this is only a transitory impact, the ensuing economic recession does potentially mean these companies not only face short-term headwinds but also a longer road to recovery. Overall, however, the fund has been very resilient versus the broader markets,” says Gold.

The Worldwide Healthcare Trust has been aggressive in repositioning the portfolio in response to coronavirus, says Polischuk. He describes the trust’s active share in normal conditions as very high, at around 70-80% on a historical basis. But a month into Covid-19 volatility, the investment team has moved more than 1,000 basis points of exposure across different sub-sectors. He describes it as “a flight to safety”, with more of a focus on quality and large-cap exposure.

Takeda Pharmaceuticals is one of the buying opportunities Polischuk is tapping into. He attributes the Japanese company’s poor performance, down by 24% during Q1, to its balance sheet and credit market concerns, even though it is one of the names working on a coronavirus plasma therapy that draws antibodies from patients who have recovered from Covid-19.

“This stock is so cheap,” he says. “It has a well-diversified portfolio, cashflow that will be able to cover all of its debt obligations and maybe there will be an interesting upside from this particular therapy.”

Pictet Biotech increased weightings to more mature companies with good cashflows while dialling down exposure to small-cap companies that may be more reliant on equity raises for short-term funding requirements.

Haueter notes, however: “The biotechs are quite well funded and should be able to bridge that gap in terms of time delay. But we need to wait and see how the situation evolves further.”

The $646.9m Healthcare Fund, which allocates around 40% to healthy living alongside pure healthcare stocks, added to Clorox, which makes bleach-based products, and has been one of the top performers in the portfolio in the year to date. It rose by 13% during Q1.

“Hygiene has been an important segment, especially in the current health crisis where the first response has been that everybody is washing their hands,” says Haueter. The team also added to Reckitt Benckiser.

Healthcare has been more defensive than normal during coronavirus sell-off

Axa Framlington Biotech, the only fund in the space to eke out positive performance in Q1, was positioned defensively going into the sell-off with large-cap exposure and high-quality mid-cap exposure, according to portfolio manager Linden Thomson. The fund has tapped into small-cap names at low valuations during the selloff. Thomson reckons the biopharma sector has been more defensive than normal, thanks to the “perception that this is the sector that could bring about an end to the coronavirus pandemic”.

But while the MSCI World Healthcare Index has fared better than overall markets, there has been a marked divergence in performance, says John Bowler, manager of the £297.5m Schroders Global Healthcare Fund.

“The main impact of the coronavirus policy measures has been to stop most surgical procedures in hospitals and cancel the majority of patient visits to non-essential provider settings, such as annual health checks and dentists.”

Hospital and medical equipment companies have therefore fallen “precipitously”, says Bowler, who has reduced exposure to companies most exposed.

Pictet has also reduced exposure to companies focused on electives surgeries, although Haueter adds: “There’s only so much time you can delay your heart surgery. At some point you need to do it and there will be a comeback in demand for those types of interventions after we’ve weathered the worst of the storm.”

Are other parts of the market more attractive?

Morningstar Investment Management has long been positive on healthcare stocks, particularly within the US market, but according to portfolio manager Mark Preskett, they currently find other sectors more attractive.

“While it is understandable that investors are more attracted to healthcare stocks now, they are clearly paying a higher relative price compared with other parts of the market.”

Energy is one such sector, says Preskett. While the MSCI World Healthcare Index has fallen by just 24 basis points in the period since the coronavirus sell-off, which kicked in on 20 February, the MSCI World Energy Index has dropped by 35.13%, according to FE Fundinfo.

However, BMO Global Asset Management manager Peter Hewitt, who runs three portfolios of investment trusts, says investors with a three- or five-year time horizon have no reason to shun healthcare in favour of sectors that have been more battered by the crisis.

“If you’re a brilliant market timer, you might get six months when consumer discretionary, oil or banks perform. I’m rubbish at timing things short term; I try to look at investment companies with longer- term growth prospects. Almost all the ones that have done well, if not healthcare or technology specialists, have large parts of their portfolio there.”

Healthcare and biotech investment trust performance Q1 2020

Source: FE Fundinfo

James Anderson’s Scottish Mortgage and the European Opportunities trust, managed by Alexander Darwall, are two such examples, says Hewitt. The fourth largest holding in Anderson’s £9bn investment trust is US genomics business Illumina. Darwall’s weighting to Spanish business Grifols, which is working on a Covid-19 therapy, and French business Biomerieux, focused on the testing side, joined the portfolio’s top-10 holdings during the course of March.

Hewitt’s portfolios hold about 10% in specialist healthcare vehicles, which he says helped recent outperformance. In the year to mid-April, the Managed Portfolio Income fell 21%, while the Managed Portfolio Growth portfolio was down 16.9%. The FTSE All-Share benchmark lost 25.8% during the same timeframe. The unit trust version of his strategy, BMO MM Investment Trust, fell 14.2% over the period. Even in the income portfolio BB Healthcare is one of the biggest holdings, with a 3.5% weighting, something he says is possible because of the investment trust structure, where distributions can be made from capital.

“I could own lots of UK equity income or global equity income funds and they will all hold Royal Dutch Shell, utilities, banks and financials. But if you can get exposure to some quite exciting areas, which pay you a dividend, then I think that will help the portfolio.”

Worldwide Healthcare and Syncona are among some of the other healthcare and biotech trusts that feature in Hewitt’s top-10 holdings. While Haueter does not expect the healthcare industry will enjoy a significant economic boost as a result of a Covid-19 treatment – “and it shouldn’t” – she believes the industry will benefit from improved public perception, particularly in the US where there is a lot of concern about drug prices.

“That’s really relevant because the perception in the public of the industry was quite negative.” That would make it hard for US political candidates to rail against the healthcare industry, says Polischuk, a factor that has weighed on the sector in the past.

He adds: “Not only has Bernie Sanders pulled out of the US election race and now it’s going to be Biden versus Trump, but I think there’s a lot of goodwill being built in the industry because of the collective efforts around trying to bring about a therapeutic, diagnostic, treatment or vaccine for Covid-19.”