Can healthcare and biotech’s strong run continue?

8th September 2013

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The news that scientists have created a human ‘mini-brain’ – with all its Franken-science associations – excited and appalled in equal measure. But healthcare fund managers believe that we are on the cusp of an exciting new era in healthcare that will drive the sector forward and pay dividends for investors. Investment journalist Cherry Reynard reports.

The sector has been a significant outperformer over the past three years. Over that period, the majority of generalised healthcare funds have returned more than 60%, with the top performer – the Polar Capital Healthcare Opportunities fund – up 94%. The Biotechnology sector, after a lengthy period out of fashion, has seen an even giddier rise: The Biotech Growth Trust, for example is up 167% over the same period on a Net Asset Value basis. Among open-ended funds, the Axa Framlington Biotech fund is up 133%.

The crucial question for every wannabe healthcare investor is whether that performance can be sustained. The long-term demographic case for health care has been extensively made: people are getting older and fatter, which means that they are becoming more dependent on pharmaceuticals to prolong and enhance their lives or manage some chronic conditions. Equally, as emerging markets develop, a more demanding middle class emerges, keen to have access to Western style medicine. This trend has long known and understood, but is, arguably, built into valuations so what has been driving healthcare stocks more recently?

Stephen Peters, investment trust analyst at Charles Stanley, says that the key driver for the biotechnology sector has been merger and acquisition activity. He believes that this may well continue: “While interest rates are low and pharmaceutical companies are not finding blockbuster drugs, this activity may continue.” Certainly merger and acquisition activity is ongoing across the sector. This week alone, BioMérieux, the quoted French diagnostics company said it would buy US rival BioFire for $450m to expand its role as a global provider of tests for bacterial infections Ft.com reported, while India’s government gave the go-ahead for US-based pharmaceutical company Mylan’s $1.6bn acquisition of Indian vaccine and injectable-drug maker Agila Specialties and Japanese nutrition and drugmaker Otsuka Pharmaceutical put out a tender offer to acquire California-headquartered Astex Pharmaceuticals for $886m.

Another driver has been scientific progress. This is not just around mini-brains, but in a variety of areas: For example, John Bowler, manager of the Schroder Global Healthcare fund, says that there are profound changes in the treatment of cancer, which is likely to propel the sector forward over the next few years: “To date, there have only been modest, incremental improvements in (cancer) therapy, with one or two exceptions… we now have a deeper understanding of why tumour cells evade our immune system.  In particular, we now know a number of the signals that tumour cells send that disarm the immune system.  It is by targeting these signals that new therapies are emerging.”

He points out that the number of new drugs approved per annum by the US Food & Drug Administration risen to new highs after a lull in recent years. This is not because the FDA is becoming more lax in its assessments, but because drugs are getting better. Geoff Hsu, manager of the Biotech Growth trust, agrees: “This year has seen the largest number of drugs approved in a single year. The climate is increasingly friendly and that is because the quality of drugs is very much better…the science has improved dramatically.” Hsu points to groups such as Gilead Sciences, which has developed a drug for Hepatitis C that has 100% cure rates after 12 weeks of treatment and says these are ‘real medical advances, rather than simply me-too drugs’. This is good news for patients and investors alike.

The managers also believe that in spite of the recent run of strong performance, healthcare valuations – for the most part – still look compelling. Gareth Powell, manager of the Polar Capital Healthcare Opportunities fund, says: “Biotechnology has done very well, but only broken out of a 12-year trading range last year. Multiples are still low on an historic basis and are completely justified by the sheer level of innovation coming from the sector. There are still opportunities.”

But what of the big pharmaceutical companies? These have been widely backed by respected managers such as Neil Woodford, manager of the Invesco Perpetual Income and High Income funds, who believed that the market was obsessing over the patent cliff and not putting enough value on their pipeline of drugs. He has held large positions in, for example, GlaxoSmithKline and AstraZeneca. Bowler says that the management in the larger pharmaceutical groups has improved: imposing better capital allocation, stronger cost discipline and returning cash to shareholders. He says that having long been an area for ‘value’ investors, these stocks are now coming onto the radar for growth investors too.

The sector remains popular with global fund managers. Andy Headley, manager of the £2.9bn Veritas Global Focus Fund, speaking to Portfolio Adviser, said: “There has been sea-change in attitude on the part of senior management in the pharmaceutical companies. Research and development investment used to be haphazard, with lots of scientists with pet projects. Now companies such as GlaxoSmithKline analyse each project in detail including the cost of developing a drug, its chance of getting approval, likely revenue and competing drugs in order to calculate if they will earn a satisfactory return on each project. They are starting to see the benefits of that now and are much more focused on shareholder returns. There has been some re-rating in these stocks and we believe it will go further.”

Patrick Connolly, financial planner at Chase de Vere agrees: “Pharmaceuticals companies have performed well in recent times and many have reasonably strong balance sheets, but are still potentially sitting at decent valuations. These valuations are in part due to concerns about the patent cliff, with company’s cash flows under threat as patents expire and the market nervous of the risks of hugely expensive research and development expenditure being unsuccessful. We believe that healthcare and pharmaceuticals stocks are a sensible defensive play in the current environment and should perform comparatively well if there isn’t a significant upturn in the global economy….we prefer to get exposure through broad-based funds such as Invesco Perpetual Income and High Income and Newton Global Higher Income.”

These are buoyant times for the healthcare sector. It has certainly had a strong year, but many experts say there may be more to come.

2 thoughts on “Can healthcare and biotech’s strong run continue?”

  1. Pierce Cook-Anderson says:

    A timely article. Thanks Cherry.

  2. Gurjender singh says:

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