Healthcare is renowned for its resiliency during market drawdowns. Steady consumer demand for hospitals, medicines and medical devices, irrespective of market conditions, means that approximately 85% of the sector’s assets, which include pharmaceuticals, medical devices, and health care services, demonstrate ‘defensive’ characteristics and growth potential.
The remaining 15% is made up of biotechnology firms. This subsector includes innovative – and inherently volatile – small- and mid-cap companies that offer greater growth potential, as well as large-cap firms that reflect more defensive qualities and tend to behave similarly to traditional pharmaceutical companies.
These defensive and growth characteristics are reflected in historical returns. Take 2022 as an example: powered by high innovation levels and an influx of meaningful clinical data, the MSCI World Health Care Index returned 5.4%, a significant result in comparison to the 17.7% decline of the MSCI World Index.
A combination of rapid growth and innovation – driven by regulatory changes, R&D spend and high demand – and historically depressed valuations has meant that the healthcare sector has continued to generate attractive investment opportunities in spite of market volatility and we expect this trend to continue.
The healthcare sector is going through a period of unprecedented levels of innovation and growth. Some of this momentum has been driven by expanded R&D purviews and budgets. For years, cancer has monopolised R&D spending in biopharma; now, drug research has expanded to other large disease categories, such as Alzheimer’s.
Last year, a new drug, Leqembi, offered clear proof that it can slow the rate of cognitive decline in the early stages of the disease. Leqembi was one of dozens of clinical successes in 2022, setting the stage for a potential surge of drug launches in 2023 with a total of 75 compounds up for review by the Food and Drug Administration (FDA) this year.
To encourage this type of research and innovation, regulators have recognised the need to create pathways that accelerate the review process for medicines targeting highly unmet medical needs. The result has been a dramatic jump in the number of new drug approvals.
From 2018 to 2022, the FDA greenlighted nearly 250 novel drugs, up 100% from 15 years ago. Similarly, over the same five-year period, the European Medicines Agency (EMA) approved more than 200 therapies.
Just as new therapies are emerging, demand for medical care is exploding. The expansion of public and private insurance coverage is a driver. In China, for example, 95% of the population is now covered by the country’s basic insurance program, thanks to government reforms over the past decade. Demand is also being driven ever higher by ageing populations.
By 2050, it is expected that roughly 16% of the world’s population, and 28.5% of Europe’s, will be over the age of 65, a cohort that typically spends around three times more on healthcare than those who are younger.
This combination of innovation, a regulatory shift and rising demand has helped to lift revenues for the sector. Sales of biotech blockbuster drugs (defined as having annual sales of $1bn or more) exceeded $400bn in 2021, 70 times what they were roughly two decades ago. Covid-19 products – a market that didn’t exist three years ago – contributed $75bn to total revenue for the year.
Of course, the growth drivers we have seen in the healthcare sector are not without their risks. Research shows that 90% of compounds that enter human clinical trials never make it to market and, of those that do, we’ve found investors over- or underestimate a product’s commercial potential 90% of the time. Such odds can result in sharp equity moves. In fact, over the past decade, the disparity between top- and bottom-performing stocks in healthcare was the largest of any sector.
Even so, in 2022, as rising interest rates buffeted markets, the healthcare sector outperformed broad equity indices. At the same time, investors have shown an increased willingness in recent months to reward innovation, with some stocks experiencing significant gains on positive news due, in part, to attractive valuations.
The healthcare sector’s forward price-to-earnings (P/E) ratio sits below its long-term average while hundreds of biotech companies trade for less than the value of cash on their balance sheets. Low valuations have also captured the interest of large-cap biopharma companies: several mergers and acquisitions were announced last year at premiums of more than 100%, and we believe more deals could follow in 2023.
There are challenges to investing in healthcare, as with any sector. Labour shortages, regulation, and waning Covid-related sales could weigh on some stocks. However, we believe the sector’s long-term outlook more than makes up for any near-term headwinds, and the opportunity to generate uncorrelated returns – while at the same time delivering benefits for patients – is only growing stronger.
Andy Acker is a portfolio manager at Janus Henderson Investors. The views expressed above should not be taken as investment advice.