April was yet another challenging month for global equity markets, with the healthcare sector outperforming the broader market. From a subsector perspective, pharmaceuticals, biotechnology, managed care and distributors lost less than healthcare supplies and services, life sciences tools and services, healthcare equipment and healthcare facilities, which all performed poorly in the month. The Company’s NAV decreased by -0.9% in April, behind the benchmark (MSCI AC World Daily Net TR Health Care Index) which was flat for the month.

Market review

Earnings season got underway in mid-April with some near-term, and hopefully acute, challenges overshadowing the sector’s strong fundamentals. HCA, a bellwether of the healthcare facilities sector, slumped after reporting that the labour market for healthcare professionals remained tight, with higher levels of temporary staff and wage inflation than anticipated. Other companies within facilities and services offered similar observations, but a common theme was an expectation for improvements in certain labour metrics as the financial year progresses. The earnings season also highlighted that some businesses, with different service lines and staffing needs, are better equipped to deal with the current market conditions than others.

Supply chain issues also featured with the renewed lockdowns in China causing short-term manufacturing and freight bottlenecks. The Russia/Ukraine war is also adversely impacting the availability of essential commodities used in the production of certain medical devices, with titanium and nickel two good examples. Semiconductor and electronic components have also been in short supply which has impacted some companies’ ability to deliver on orders. While these are generic challenges for many industries, it is important to note that some companies are better equipped to deal with them and that the demand for healthcare products and services remains strong.

Inflationary pressures also affected a number of companies that released their quarterly results, with energy and freight costs particularly elevated. On top of the inflationary concerns, investors were spooked by Intuitive Surgical (a manufacturer of surgical robots) comments that it noticed a slowdown in capital equipment demand by US hospitals, whose financials are stretched and are therefore redirecting funds to tackle more immediate issues. Thankfully, other MedTech companies allayed fears by stating that capex spending continues to be robust. Finally, rising inflation appears to be impacting consumer sentiment and confidence, as illustrated by Align Technology’s disappointing Q1 earnings where they reported a meaningful decline in demand for its clear aligners, very much a discretionary item. The good news for healthcare companies is the essential nature of their products and services underpins confidence in their ability to generate steady revenues, earnings and cash flow.

Near-term supply chain and inflationary pressures aside, we are encouraged to see that some of the key trends we believe will be crucial in shaping the healthcare landscape are starting to play out.

Near-term supply chain and inflationary pressures aside, we are encouraged to see that some of the key trends we believe will be crucial in shaping the healthcare landscape are starting to play out. As we have discussed previously, we think there is a growing backlog of patients who missed or delayed treatments because of the pandemic. Reassuringly, procedural volumes exhibited strong growth in the quarter (such as Johnson & Johnson posting strong results for their large-joint implant business), showing that patients’ behaviour is normalising.

Another accelerating trend is the shifting of volumes from in-patient to out-patient and Ambulatory Surgical Centre (ASC) settings which are anecdotally less affected by labour challenges and where healthcare can be delivered more quickly, conveniently and at lower cost. Finally, prevention remains a key area of focus: with Omicron less severe, perhaps due to the unstable nature of the variant or by acquired immunity across the population, routine diagnostic tests saw a significant increase in the quarter, an encouraging sign.

Positive contributors during April were Cytokinetics, Sanofi and Danaher. The strength in Cytokinetics reflects greater enthusiasm for lead pipeline asset aficamten following FDA approval and better-than-expected pricing for a competing asset, Bristol-Myers’ Squibb’s mavacamten. Sanofi produced a strong set of Q1 financial results, but importantly also reiterated FY22 guidance, albeit with an incrementally positive foreign exchange tailwind. The Fund was not exposed to Danaher which, alongside its life sciences tools and services peers, has had a difficult start to 2022.

Negative contributors were Biohaven Pharmaceutical Holding, Merck & Co and Envista Holdings. During 2021, Biohaven Pharmaceutical Holding regularly released preliminary sales numbers for key migraine asset Nurtec ODT. However, the lack of an early release for Q1 created nervous tension that is reflected in the derating of its shares. The Fund was not exposed to Merck & Co which produced a strong set of Q1 financial results driven by key oncology asset Keytruda, HPV vaccine Gardasil and its Animal Health division. Such was the strength of the first quarter results, Merck & Co’s management team upgraded full-year guidance for both revenues and earnings. The weakness in Envista Holdings reflects the company’s exposure to Ukraine and Russia, coupled with sympathy with weaker-than-expected Q1 results from dental peer Align Technology.

We initiated positions in Japanese and Swiss pharmaceuticals companies, Daiichi Sankyo and Novartis. The addition of Daiichi Sankyo primarily reflects our enthusiasm for Enhertu. Partnered with AstraZeneca, we believe its commercial potential could drive upside to near and medium-term consensus forecasts. Novartis appears to be well placed to drive strong operational performance through its Innovative Medicines business, with multiple new product launches in areas such as multiple sclerosis and cardiovascular disease. The company also has some late-stage pipeline optionality, especially in oncology. The additions were funded by sales in Amedisys, Baxter International and Hologic.

Outlook

As mentioned previously, staffing pressures, supply chain challenges and inflation have been a feature so far during the Q1 earnings season but, encouragingly, there appears to be confidence that some of these pressures will abate as the year progresses. More importantly, perhaps, there is evidence that patient volumes are picking up and that alternative sites of care are being utilised, both of which are trends we are very much focused on through investment in medical device companies and healthcare facilities and providers.

As at 4 May 2022.