Investors looking for a fast-growing sector on reasonable valuations should consider buying healthcare funds, according to analysts at Winterflood Investment Trusts.
The sector has been a mixed bag over the last couple of years.
Long-term demographic trends support the sector as an ageing population requires more care. However, last year’s US presidential campaign election weakened sentiment towards the sector, as many investors feared regulatory changes could hit growth.
“In the lead up to the US presidential election last year, the healthcare sector and political rhetoric surrounding drug pricing were never far from the headlines,” wrote Winterflood analysts Emma Bird, Innes Urquhart and Kieran Drake in a research note.
“This led to a sell-off in healthcare equities, particularly within the biotechnology sector, with valuations of the MSCI World Health Care and NASDAQ Biotechnology indices falling to well below their long-term averages.”
Sentiment has improved over the last 12 months as president Trump has since failed to implement any of the potentially significant political reforms he promised.
Indeed, healthcare stocks have rallied strongly over the past 12 months, with the FTSE All World Healthcare index up 16.21 per cent.
Performance of index over 1yr
Source: FE Analytics
During that time the four-strong IT Biotechnology & Healthcare sector has also prospered with the average trust rising by 23.45 per cent.
This outperformance has partly been due to the discount tightening in the investment company peer group, from a weighted average of 5 per cent a year ago to 0 per cent at present.
Below, the team at Winterflood Investment Trusts outline why investors should look at the sector in more detail, with long-term drivers in place while valuations, despite the recent improvement, are not expensive.
Overall, the healthcare sector could benefit from trends that have been in place for much of the last decade – ageing populations leading to rising demand for services and technological innovation.
“Innovation has seen the healthcare sector deliver rapid growth over recent years, with many companies looking to take advantage of scientific discoveries across a range of areas, including immuno-oncology and gene therapy,” the team said.
“It would also appear that scientific breakthroughs addressing numerous diseases are set to continue. Furthermore, secular growth drivers such as ageing populations in developed markets and the significant growth in the size of the middle class in emerging markets provide a favourable backdrop for demand.
“These numerous scientific advances and innovations have contributed to the healthcare sector’s considerable outperformance of broader equity markets over the last decade.”
World population aged 65 and above (per cent of total)
Source: World Bank
As well as this, many healthcare investors believe that M&A activity will continue or may even pick up as larger incumbents look to acquire smaller businesses with innovative existing technologies or promising research and development pipelines, according to the analysts.
However, valuations, in general, do not appear particularly stretched relative to broader equity markets despite the growth potential associated with the sector, the team noted.
“While the value opportunity is now less obvious than it was at the end of last year, we believe that valuations in the healthcare sector remain reasonable,” they said.
At first glance, valuations in the healthcare sector appear reasonably full, the Winterflood analysts noted, with the MSCI World Health Care index currently trading at price/earnings ratio of 17.5 times 2017 expected earnings – higher than its five-year historical average P/E ratio of 16.9 times.
“That said, the healthcare sector encompasses a broad range of sub-sectors and anecdotally there is huge dispersion in valuations across these. We would expect this to give rise to opportunities for active managers,” the team added.
Meanwhile, on a relative basis the sector looks more attractive than it does on an absolute basis, with the MSCI World index trading on a slightly higher P/E multiple (18 times) than the healthcare sector.
“The two indices are trading broadly in line with each other, whereas the MSCI World Health Care index has historically been more highly rated than the broader global equity market,” the analysts said.
“While current valuations do not offer as much of a clear opportunity as they did at the end of 2016, we believe that valuations in the healthcare sector are not stretched at present and that political risk in the sector is now considerably lower.”
The trust the team are recommending for investors is the Biotech Growth Trust, run by OrbiMed’s Geoffrey C. Hsu and Richard D Klemm, having previously recommended sister fund Worldwide Healthcare trust.
“We rate the experienced and specialist team at OrbiMed, which manages both funds, highly and continue to believe that Worldwide Healthcare has significant merits as a lower volatility way to access the sector,” the analysts said.
“We switched to Biotech Growth in July on the grounds that the political rhetoric surrounding drug pricing had somewhat died down since the US presidential election and we believe that the secular growth prospects offered by the biotechnology sector are attractive.”
Performance of trust vs sector and benchmark over 10yrs
Source: FE Analytics
The investment company has been the best performing trust (of the three with a long enough track record) over the last 10 years, returning 642.41 per cent and has beaten the Nasdaq Biotechnology benchmark by 124.79 percentage points over the period, as the above graph shows.
The trust is 11 per cent geared and has ongoing charges of 1.1 per cent, according to the latest data from the Association of Investment Companies (AIC). Its shares are currently trading on par with net asset value.