- Policy changes likely to be evolutionary rather than revolutionary
- Numerous secular drivers support the robust long-run outlook for healthcare
- Current undervaluation adds to sector’s attractions
While in most developed economies, healthcare policy has remained relatively stable, there is growing concern over potential changes in the US, which is the world’s largest healthcare market and represents about two-thirds of the main healthcare benchmark, the MSCI AW Healthcare index.
Healthcare expenses have been rising as a percentage of gross domestic product (GDP) in virtually all economies, but the increase has been most pronounced in the US where the system has historically lacked any significant incentives to control price inflation.
Increasing pressure on consumers is elevating this issue politically as the 2020 US election approaches. Since the US is the largest single market for most global healthcare companies, these concerns have depressed equity valuations.
While some policy change appears inevitable, we believe these concerns are overblown. We expect the drivers of secular growth to remain intact. Ultimately, this should prove to be a buying opportunity for investors with a medium to long-term investment horizon.
Why fears are misplaced
In our view, some changes to the US healthcare system are necessary and likely, but for several reasons, we are highly sceptical that legislators will enact sweeping policies that would meaningfully impair the viability of the sector.
- The US electorate significantly values the role of private industry in fostering innovation
- The sector accounts for some 12% of US jobs, according to data from the Kaiser Foundation
- Significant costs can be saved by shifting incentives, site of care, capping price inflation, and restructuring bio-similar regulations
- Voter support for a government takeover of healthcare is actually quite low.
As a result, we believe any actual changes are more likely to be evolutionary as opposed to revolutionary.
Valuations already reflect uncertainty
The enterprise value (EV) relative to sales (REV) multiples of healthcare companies is at near a 20-year low relative to the broader market, i.e. the MSCI AW Healthcare EV/REV relative to that of the MSCI AW index (see Exhibit 1). Significant political risk is already reflected in sector valuations, implying a compelling risk/reward going forward.
Exhibit 1: The EV/REV ratio of healthcare relative to the broader market is near a 20-year low (Sept 1999-Sept 2019)
Source: FactSet, October 2019
Healthcare demand trends are secular
Over the long term, healthcare stocks have significantly outperformed the broader market (see Exhibit 2)  and we expect this to remain the case since the primary drivers of healthcare costs are secular in nature, namely:
- Demographics - The population is aging globally & healthcare utilisation typically rises with age
- Life style changes - Obesity is rising around the world. It is a leading cause of diabetes and cardiovascular disease
- Wealth effect - Per capita healthcare spending correlates with per capita GDP, i.e. the wealthier people become, the more they spend on healthcare
- Innovation - Novel technology is keeping people alive longer
Exhibit 2: The MSCI All World Healthcare index has outperformed the MSCI All World index over a 20-year horizon (Sept 1999-Sept 2019)
Source: FactSet, October 2019
Innovative trends are strong in healthcare
In our view, the pace of innovation in healthcare is on par with that of the information technology sector. Innovation should revolutionise healthcare over the coming decades without systemic change, significantly improve patient outcomes, and potentially alleviate cost pressures. Below are some of the most significant trends:
- Declining gene sequencing costs result in increased drug targets
- Artificial intelligence enables analysis of highly complex biological data for drugs and diagnostics
- Innovations in drug delivery enable potential curative therapies
- Innovation in materials, robotics and miniaturisation enable precision diagnostics, surgical and wearable devices
- Innovations in communications are leading to the emergence of virtual healthcare services.
In an increasingly discerning purchasing environment, innovation is set to become the barometer of a company’s success. We believe potential investments can be sorted into three general categories:
- Companies driving disruption - investable
- Companies benefiting from disruption - investable
- Companies being disrupted - avoid
Rising concerns over stricter regulation have caused the healthcare sector to significantly underperform the broader market, taking valuations to historically low levels. While pricing power is likely to weaken for some companies, we believe those companies enabling or benefiting from innovation will thrive. Furthermore, we believe the drivers of global healthcare demand are secular and likely to remain strong. As such, we believe now is a good time to be investing in healthcare.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
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