A combination of unsustainable spending, misaligned incentives and centralised, inflexible care has contributed to the poor state of healthcare stocks, according to Baillie Gifford managers Douglas Brodie and Spencer Adair.
However, while the pair noted a number of challenges for the sector there are several opportunities likely to emerge in the years ahead for those willing to look through the noise.
The sector has come under increased pressure more recently due to some of the uncertainty surrounding the US presidential elections, where healthcare became a battleground for candidates Donald Trump and Hillary Clinton.
Indeed, Ryan Hughes, head of fund selection at AJ Bell Investments, said healthcare stocks had suffered during the presidential campaign, as both candidates vowed reforms of US healthcare or punitive tax measures.
Hughes said: “I think that political rhetoric kind of stopped investors in their track and made investors think rationally again about valuation.
“It’s probably fair to say that they had got ahead of themselves and that some of that run was huge and particularly when you look down at the biotech space a lot of these companies were growing but hadn’t really developed anything yet – it was all on the promise.”
The election of Donald Trump saw other headwinds develop as the new president set about scrapping Obamacare, failing in his first attempt.
Hughes said: “That’s not to say that good quality companies can’t do well but as a sector they’re going to be challenged because investors know the Trump rhetoric and that will mean their focus is elsewhere.”
Performance of S&P 500 Health Care vs S&P 500 over 1yr
Source: FE Analytics
As well as this, of the six funds in the IA Global sector to be in the top quartile over five years but bottom quartile over the last 12 months, three are healthcare funds showing a potential changing of the guard. Indeed then, it appears the sector faces a number of challenges.
FE Alpha Manager Adair, an FE Alpha Manager who co-manages the Monks trust and several other portfolios, noted that “healthcare is sick” highlighting high levels of spending and entrenched ways of care.
“The Red Cross recently warned that hospitals in the UK were in a state of human crisis,” said Adair. “The US spends more per capita than anybody else and it has at best average healthcare cover.”
The manager said costs were a key issue in the sector, including people and infrastructure.
He said: “There are more sick people who result in more hospitals and more nurses and doctors, there is no scalability in that.”
However, the managers noted that greater innovation could help control costs with some “relatively easy wins”.
Brodie, also an FE Alpha Manager and lead manager of the Edinburgh Worldwide trust, said innovation of data could be a driver for opportunities in the sector, describing it as one of the biggest new challenges for technology firms.
Adair added: “Technology will offer up opportunities in a way it hasn’t before. Over the years that should allow costs to greatly fall.”
The pair highlighted Dexcom as one source of innovation, using smartphone and sensor technology to monitor blood/sugar levels for diabetic patients.
Such companies represent a convergence of technologies and greater empowerment of patients, the pair noted.
The managers also highlighted other companies such as Oxford Nanopore Technologies and Grail, which aim to lower costs in the area of human genome research.
Adair said: “Healthcare is in crisis today, but we believe it can be on the cusp of a ‘golden wave’.”
The ‘golden wave’ is described by the pair as “slow but powerful” and has delivered lasting change in the sector, such as developments in surgery, infectious diseases, chemical and, more recently, biotechnology.
Looking ahead, the managers believe that greater understanding of genetics to tackle human diseases and increased integration of data & healthcare could provide the next ‘golden wave’ in the sector, offering up new opportunities for investment outside the traditional healthcare companies.
Both global growth trusts overseen by the managers have a significant exposure to the healthcare sector.
The £1.5bn, three crown-rated Monks trust has an 8.8 per cent exposure to the sector, while the small-cap focused £330.3m Edinburgh Worldwide trust holds a number of healthcare and related stocks in the portfolio.
Performance of trusts YTD
Source: FE Analytics
The Monks trust, which is overseen by Adair with lead manager Charles Plowden and co-managed by Malcolm MacColl, has delivered a strong double-digit return of 17.74 per cent, so far this year. It has an ongoing charge figure (OCF) of 0.59 per cent and is trading at a premium of 0.02 per cent, according to Winterflood Investment Trusts.
Meanwhile, Edinburgh Worldwide – which Brodie manages alongside John MacDougall – has risen by 13.98 per cent. The trust has an OCF of 0.92 per cent and is trading at a discount of 9.89 per cent, according to Winterflood.