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Fund Manager Commentary As at 29 October 2021
Global equity markets were fairly buoyant in October, with healthcare modestly underperforming. A strong earnings season thus far, easing supply-chain concerns and greater confidence in a post-pandemic economic recovery appear to have been the primary drivers behind the performance. Looking at the healthcare subsectors in greater detail, managed care and life science tools and services were the standout, positive performers, while healthcare supplies and healthcare facilities struggled. The Company’s NAV increased by 1.1% in October, which was behind the benchmark (MSCI AC World Daily TR Net Health Care Index) which was up 2.0% for the month.
Market activity
In a modestly positive, but perhaps unsurprising development, congressional Democrats and the White House announced a drug pricing agreement to be included in President Biden's reconciliation bill that appears to have excluded the most draconian measures. Presumably with not enough votes to get across the line, the absence of a far-reaching drug pricing provision in the package will likely be seen as a disappointment for many in the Democratic party, especially the progressives, but could offer near-term relief for the bio-pharmaceuticals industry. According to a White House Statement, key plan elements are (1) Medicare Part D benefit redesign to cap out of pocket costs for beneficiaries at $2,000; (2) inflationary price caps by imposing a tax penalty on drug price increases with inflation encompassing both government and commercial plans; and (3) allowing limited drug price negotiation by HHS (the US Department of Health and Human Services) for the 10 highest spend drugs in Medicare Parts B&D, rising to 20 over time, that are past nine years post-approval for small molecules (12 for biologics) from 2025.
On a more constructive note, the package did include provisions to expand part of Medicare, Medicaid and the Affordable Care Act (ACA). Under the expansion, Medicare would offer hearing benefits and tax credits will be provided for up to four million uninsured Americans in states that have not expanded Medicaid under the ACA. Biden also plans to reduce premiums for nine million people who are covered through the ACA marketplace by an average of $600 per person. For example, a family of four earning $80,000 per year would save nearly $3,000 per year, or $246 per month, on health insurance premiums. Experts predict that more than three million people who would otherwise be uninsured will gain health insurance, a clear positive for the healthcare insurance industry.
October was a very busy month for financial reporting, with the healthcare sector performing reasonably well despite some headwinds. The greater-than-expected surge with the COVID-19 Delta variant impacted several sectors, especially the medical device sector, during August and the first half of September. Thankfully, the impact of the virus started to recede through the second half of September and into October, offering comfort that the worst of the Delta variant could be behind us. Inflation and supply-chain challenges have also been a factor through the earnings season, with some companies and subsectors better equipped than others to either absorb those costs or pass them on to customers. Staffing challenges, both in terms of recruiting and retaining employees, as well as wage inflation have also proven to be a factor with the facilities and providers most affected. COVID-19 has had a dramatic impact on the global healthcare workforce, creating pressure points we hope will start to dissipate as we move into a post-pandemic environment.
Fund activity
Positive contributors during the reporting period were Steris, Moderna and UnitedHealth Group. Infection prevention specialist Steris enjoyed a positive re-rating during the period but delivered little by way of news flow. The positive contribution from US biotechnology company Moderna reflects a lack of ownership during the period with some of the excitement around the company’s mRNA platform starting to wane. Managed care organisation UnitedHealth Group produced a strong set of 3Q21 financial results and, more importantly, gave encouraging commentary around the earnings potential of the business in 2022.
Negative contributors in June were Encompass Health, Alnylam Pharmaceuticals and Merck & Co. Encompass Health’s weak share-price performance during October reflects the elongation of the timetable for a key catalyst, that of spinning out its home health and hospice business. On the 3Q21 earnings, the management team announced they are targeting a transaction (carve-out IPO, spin-off or split-off) some time in the first half of 2022, which represents a delay relative to consensus expectations. The correction in Alnylam Pharmaceutical’s valuation is a result of the surprising news that CEO John Maraganore is to step down at year-end 2021 after 19 years with the company. Merck & Co, a stock where we have no exposure, had a very strong month driven by a strong set of 3Q21 financial results and some positive results for an oral anti-viral medication called molnupiravir. In a Phase III trial, molnupiravir reduced the risk of hospitalisation or death by approximately 50% compared to a placebo for patients with mild or moderate COVID-19. The Merck & Co management team then suggested molnupiravir could bring in $5bn-$7bn in sales through the end of next year, assuming it gains US authorisation in December.
In terms of portfolio changes, we added Abbott Laboratories and Zimmer Holdings. Abbott Laboratories, a high-quality, healthcare equipment company, has the dual benefit of being exposed to the COVID-19 testing market and also has exciting growth drivers in the areas of diabetes, stroke prevention and cardiovascular intervention. Also, equipment company Zimmer Holdings is highly geared to a recovery in the elective procedure market, with leading positions in the fields of hip and knee replacements. As the impacts of the Delta variant subside, there is a school of thought that the market will see not just a recovery in elective procedures, but some catch-up from the backlog of patents that has accumulated during the acute phases of the pandemic. The positions in Abbott Laboratories and Zimmer Holdings were funded from exits in hearing aid manufacturer GN Store Nord and healthcare equipment manufacturer Koninklijke Philips.
August to September was challenging, with individuals, healthcare workers and businesses all trying to manage through the dramatic impact of the COVID-19 Delta variant. Thankfully, it does feel the worst is now behind us, and we can start to think about life in a post-pandemic world. With regards the equity markets, we remain constructive on the outlook for healthcare, especially for established, large-cap companies at the higher end of the quality scale. That conviction will grow further if we start to see evidence that the market is moving through the mid-phase of the economic cycle.
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
Historical Fact Sheets