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Why investors shouldn’t overlook the healthcare sector

22 April 2024

Investing in the healthcare sector offers protection against the possibility of an economic downturn as well as diversification away from the hottest parts of the market.

By Greig Bryson,

Nikko Asset Management

Ignoring the healthcare sector has been easy to do over the past couple of years, even though the case for owning it has never been stronger.

Part of the reason the healthcare sector has been overlooked is due to the financial volatility caused by the Covid-19 pandemic. Some companies benefitted from increased demand for their products and services during the dark days of 2020-2021 and then lost out as (thankfully) the pandemic subsided. Others lost out and then benefitted, as patients returned to their doctors for more routine healthcare needs.

Over the past couple of years, many healthcare companies have been labelled as ‘too difficult’ due to the challenges of determining their financial standing. This includes assessing whether they were on the positive or negative side of the ledger, and predicting when ‘normal’ demand might re-emerge.

Time and patience have been necessary to reveal the answers. As we move through 2024, the fog of uncertainty is starting to lift, providing a clearer perspective. It is now widely accepted that a fair picture of Covid-adjusted trend growth can be obtained by combining two years of pre-pandemic growth rates, two years during the pandemic, and two years post-pandemic.

Even if the healthcare sector has endured a difficult 2022-2023, we will not be afraid to add to our positions in areas where we believe that the trend growth looks strong and sustainable, and the valuation attractive. Our holdings in the life science tools subsector, such as Danaher and Bio-Techne, are good examples.

Due to unprecedented post-pandemic destocking, a Chinese regulatory clamp down and a necessary return to more focused investments by the biotech industry, 2022 and 2023 have been difficult years. However, we believe that we are only in the very early stages of a new wave in scientific/medical advances – one in which a greater understanding of the human genome allows us to target new areas for medicines with artificial intelligence (AI) expediting the identification of treatments that are most likely to work. Consequently, the order books at Danaher and Bio-Techne could start to fill up quickly as we move into the second half of 2024.

A return to growth should allow the life sciences and tools subsector to recouple with (or even outperform) other growth sectors such as technology that consistently deliver high cash returns on investment. The tech sector quickly addressed its own post-Covid demand growth blip through very assertive cost cutting and the rise of AI.

Why take an umbrella when it is sunny outside?

It is also fair to note that economic conditions have remained better than many observers expected. In particular, labour markets have been tight – allowing positive real wages in many sectors and supporting consumer confidence.

Why increase your exposure to a relatively defensive sector like healthcare when the economy is purring, the US Federal Reserve is about to cut rates and we could enjoy the softest of soft landings?

Given the optimism observable at present, in terms of stock market levels and financial conditions, we do think that a bit of insurance makes sense – just in case interest rates do not come down as quickly as expected or if emerging pockets of economic softness grow in size.

Our most defensive holdings within healthcare all have stock-specific attractions that matter more to us than their average beta of 0.7. 

Cencora, Elevance and Encompass Health are all expected to benefit from sustained, demographics-led demand growth; they also offer services that will be indispensable in lowering the cost of healthcare delivery.

Cencora stands to benefit from improved distribution dynamics as $200 bn worth of US prescription drugs lose patent protection over the coming five years, a change that will also benefit patients.

Elevance has embraced value-based care, tying the payments it receives as a healthcare insurer to the health benefit received by patients (and replacing the old, less efficient fee-for-service model).

Meanwhile, Encompass Health’s inpatient rehabilitation facilities are increasingly recognised as providers of the best quality post-acute care for patients. Often, they offer a more cost-effective solution compared to alternatives such as nursing homes or general hospitals.


You don’t want all your eggs in one (AI) basket

By staying invested in healthcare, it is not just the possibility of an economic downturn that we are protecting our clients’ capital against. The sector also offers welcome diversification from some of today’s most exciting parts of the market. 

We are firm believers that the infrastructure for generative AI will be developed, even as we wait for the emergence of pivotal applications. We do not have to wait, however, for healthcare’s socio-economic necessity to be established.

We remain strong supporters of the healthcare sector. In addition to the well-known demographic drivers (ageing societies, rising prevalence of chronic illness, etc.), innovation is enabling structural changes in healthcare delivery and in our view, these changes will confer years of strong organic growth opportunities if we choose the right companies.

Greig Bryson is a portfolio manager, global equity at Nikko Asset Management. The views expressed above should not be taken as investment advice.

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