Compelling valuations and a bright outlook for healthcare - October Trust Update

Market and sector review

Global equity markets delivered positive returns in October. While the artificial intelligence ‘super-cycle’ continued to influence overall market sentiment. The onset of the third-quarter earnings season also shaped performance across sectors: information technology, healthcare, consumer discretionary and utilities stocks performed well, while the real estate, materials and financials sectors lagged. Within healthcare, life sciences tools and services, distributors, facilities and pharmaceuticals had a strong month, whereas healthcare information technology, services, managed care and equipment were weaker.

In the US, the federal government entered a shutdown on 1 October, which limited the flow of official data during the month. Even so, the Bureau of Labor Statistics released the September inflation numbers which came below expectations, but there was no update on the state of the labour market. Despite the data ‘gap’, the Federal Reserve also proceeded with another 25 basis points interest rate cut, pushing the benchmark rate to its lowest in the past three years. Given the low visibility caused by the shutdown, the trajectory for future cuts looks unclear but the October decision clearly highlights the Fed’s concerns about a stalling labour market.

As it pertains to healthcare, October saw another deal being struck between the US administration and a pharmaceuticals giant, in this case AstraZeneca. The details of the deal was broadly similar to Pfizer’s, with the company committing to price-lowering measures in certain channels in the US, a multi-year US investment programme and, in return, securing a three-year delay to prospective Section 232 pharmaceuticals tariffs.

In parallel, the FDA issued draft guidance aimed at streamlining biosimilar development that, if finalised, should lower the time and cost to market and support biosimilar adoption.

Finally, several companies in the sector announced their Q3 earnings. By and large, life sciences tools and services posted good results as their underlying markets showed signs of a recovery. Facilities also had robust sets of numbers, delivering EBIDA growth above expectations, despite volume growth moderating.

Equipment, pharmaceuticals and managed care had more mixed results, driven more by company-specific dynamics.

Fund performance

The Company’s NAV increased by 6.7% in October, ahead of its benchmark, the MSCI All Country World Daily Net Total Return Health Care Index, which was up 5.4% for the month (both figures in sterling terms).

Positive relative contributors relative to the benchmark in October were Avidity Biosciences, Exact Sciences and AbbVie.

The strong performance from Avidity Biosciences was a result of it being acquired by Novartis in a deal worth roughly $12bn.

Not owning AbbVie had a positive impact to performance as the company reported Q3 results which failed to impress investors’ high expectations.

There was no direct news flow concerning Exact Sciences.

Negative relative contributors in the period under review were Intuitive Surgical, Penumbra and Encompass Health.

The lack of exposure to Intuitive Surgical was a drag to performance as the surgical robot manufacturer posted impressive Q3 results.

With the sector at a 25-year low in terms of its S&P 500 weighting and carrying attractive relative valuations, the outlook for delivering returns looks extremely compelling.Penumbra’s share price struggled in the month despite presenting strong clinical data as investors worried about competition and a lack of updates from the FDA on the much-anticipated approval of a new product.

Encompass Health suffered a similar fate to AbbVie, with Q3 earnings failing to meet investors’ expectations.

During the month, we initiated positions in Nuvalent, West Pharmaceutical Services, CVS Health, Ionis Pharmaceuticals, Hansa Biopharma, Ottobock, and Boston Scientific.

Boston Scientific, a leading medical equipment manufacturer, and West Pharmaceutical Services, a specialist in pharmaceuticals packaging and containments, were bought with the view that both companies should experience positive earnings revisions and are offering a compelling opportunity given valuations and the growth on offer.

CVS Health, whose businesses span managed care, pharmacy benefit management and retail pharmacy, should, in our view, continue to deliver operating income growth, supported by pricing in its Medicare Advantage book and ongoing Pharmacy Benefit Management (PBM) momentum.

We are constructive on the pipelines at Nuvalent, Hansa Biopharma and Ionis Pharmaceuticals and in the latter’s case, we also believe the revenue opportunity from commercial assets is underappreciated.

Finally, we participated in the IPO of Ottobock, a leading orthopaedics technology manufacturer (prostheses and orthotics), which listed at a compelling valuation, with scope for high single-digit top-line growth and margin expansion.

These additions were funded by full exits from Avidity Biosciences, Abbott Laboratories, Edwards Lifesciences, Steris and Intuitive Surgical.

Outlook

With policy fears in the US appearing to ease and key regulatory bodies such as the FDA appearing to function as normal, the outlook for healthcare investing feels much brighter now than it has for some time. With the sector at a 25-year low in terms of its S&P 500 weighting and carrying attractive relative valuations, the outlook for delivering returns looks extremely compelling.