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Fund Manager Commentary As at 26 February 2021
Global equity markets’ uncertain start to 2021 was evident once again in February, delivering very modest gains, with healthcare a noticeable under-performer. Discussed in greater detail below, rising rates and upwards inflationary pressure are weighing on certain sectors, including pockets of healthcare, with those that fall into the “momentum/growth” bucket suffering the most. Looking at the subsectors in greater detail, facilities and managed healthcare were the best performers in February, with life sciences and tools, biotechnology and pharmaceuticals struggling. The Company’s NAV declined 2.7% in February, which was ahead of the benchmark (MSCI AC World Daily TR Net Health Care Index) which declined 4.5% for the month.
Rising rates, a steepening yield curve and inflation were very much the focus of attention during February. An environment that can be problematic in the short term for highly valued, long-duration assets such as technology, and to a lesser degree biotechnology, life sciences and tools, and pharmaceuticals. As a result, we believe there is some near-term rotation as portfolios reduce their exposure to technology, and pockets of healthcare, and increase their exposure to areas like financials, basic resources, and oil and gas. Positive real-world COVID-19 vaccine data is also adding momentum to the re-opening trade, an observation that is encouraging for areas of the market including travel and leisure. AstraZeneca’s vaccine, for example, is able to reduce the risk of COVID-19-related hospitalisations by 94% after the first dose (which compares favourably to Pfizer/BioNTech’s vaccine at 85%).
February contained a number of updates that are supportive of some of the underlying themes in healthcare that we believe will drive medium-term growth and, hopefully, yield interesting investment opportunities. We continue to see evidence that the healthcare industry is investing in technologies and services that will make the delivery of healthcare more efficient. During the reporting period, Brookdale Senior Living announced it has agreed to sell 80% of the equity in its hospice, home health and outpatient business to US hospital operator HCA Holdings. This is an interesting investment by HCA in a business that operates 84 outpatient centres, 57 home health agencies and 22 hospices – all locations that could offer lower-cost settings to deliver care. Along similar lines (i.e. delivering care in a lower-cost setting), Cigna announced its intention to acquire MDLive, one of the largest telehealth vendors in the US with particular expertise in the fields of behavioural care and dermatology.
Outsourcing is another industry mega-trend we believe is gathering sustainable momentum, with clinical research organisations (CROs) very well positioned to capitalise. In alphabetical order, CROs IQVIA, PPD, PRA Health Sciences and Syneos Health all produced strong Q4 2020 financial results, coupled with robust outlooks for 2021. On the theme of consolidation, we witnessed a couple of deals in February, with ICON looking to acquire CRO peer PRA Health Sciences, and US pharmaceutical company Merck & Co looking to acquire biotechnology company Pandion Therapeutics. On 26 February, ICON announced it has entered into a definitive agreement to acquire PRAH Health Sciences for a consideration of approximately $12bn. With modest customer overlap, ICON believes the combination will address the growing need for decentralised trial solutions. Interestingly, technology appears to be at the fore with the company focussing on mobile solutions, connected health platforms, home health services and wearables expertise. Merck & Co’s proposed acquisition of Pandion brings with it a pipeline of immune modulators with potential utility in auto-immune disease such as ulcerative colitis and systemic lupus erythematosus.
Positive contributors from active positions were Horizon Pharma, PRA Health Sciences and Hill-Rom Holdings. Horizon Pharma continues on a path of exceptional execution, with lead drug Tepezza for thyroid eye disease (TED) generating sales >$800m in 2020 (which compares very favourably to the original guidance of $35m-$40m). The stock also benefitted from a competitor update, with Immunovant announcing they were pausing their TED studies due to evidence of increased LDL cholesterol levels with their asset. PRA Health Sciences’ strong execution continues, but it was the $12bn bid from ICON that was the primary driver of the outperformance in the period. Hill-Rom Holdings had no material news in the reporting period other than another strong set of financial results (Q1 2021).
Negative contributors from active positions were Quotient, Incyte and Medley. Quotient was weak due to COVID-19 still impacting timelines on their diagnostic development programs, which remains hugely frustrating but reflects the challenges that a number of development stage companies are still coping with. The technology remains disruptive and the company out of favour with investors but we retain our optimism. Medley announced encouraging long-term revenue and margin goals but over the short to mid-term will invest more than was expected, causing the underperformance. Medley also suffered from the selloff in higher growth companies in favour of more cyclical investments. While exposure to high growth in the portfolio is limited, the long-term potential for Medley should offer the potential for substantial outperformance. Incyte has struggled since reporting a solid set of financial results. The biotech sector has been weak, but Incyte appears to be struggling from a lack of confidence in its late-stage pipeline in the areas of atopic dermatitis and oncology. Updates over the next six months will be critical to addressing those concerns.
In terms of portfolio changes, we took profits in Align Technology, Sartorius and PRA Health Sciences. Both high-quality companies, with strong footholds in large, fast-growing markets, Align Technology (dental) and Sartorius (bioprocessing) are carrying valuations that are starting to feel a little stretched in the near term so felt it prudent to take profits. As mentioned above, PRA Health Sciences was subject to a bid from CRO peer ICON so we exited the position. We also sold Fresenius Medical Care and US managed care organisation Humana. Alongside the profit warning, Fresenius’ management team did reiterate its medium-term financial guidance, but to get there they will have to navigate a challenging and lengthy restructuring program. We continue to be constructive on the managed care industry but feel that concerns surrounding solvency of the Medicare Trust Fund could prove to be a near-term overhang for Humana given its exposure to the Medicare marketplace.
We re-cycled the proceeds from the sales into a number of investments that we believe feed directly into our core investment themes. One was Aptar Group, a contract development and manufacturing organisation (CDMO) should benefit from outsourcing tailwinds. We also started a position in Cooper Companies, a US-based medical device company with a potentially disruptive myopia technology, and Molina Healthcare, a business that provides managed healthcare services under the Medicaid and Medicare programs. Last, but not least, we started a position in Arcutis Biotherapeutics, a small-cap biotechnology company with an innovative, late-stage asset for the topical treatment of plaque psoriasis.
Following on from January, February contained a number of updates that underpin our enthusiasm for underlying themes and the opportunity set that healthcare presents. Management teams are continuing to make investments today, both organically and inorganically, that should drive much-needed efficiencies over the medium term. Outsourcing will continue to be an opportunity, with ICON’s proposed acquisition of PRAH Health Science providing further evidence that, especially in the world of CROs, is it not just a short-term phenomenon. We believe that strong balance sheets will continue to be deployed in a highly fragmented market, as companies look to acquire technologies and platforms as well as pursuing external avenues of growth. Last, but not least, prevention may also continue to be a central pillar of healthcare systems, with no better example offered than the COVID-19 vaccines’ ability to keep patients out of hospital.
James Douglas
James studied medicinal chemistry and has worked in healthcare, in sales, research and fund management, throughout his career
Gareth Powell
Gareth worked at a pharmaceutical company and in academic laboratories before setting up the healthcare team in 2007
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