Macro backdrop

May was a volatile month for global equity markets, with the healthcare sector performing in line with the broader market. From a healthcare subsector perspective, pharmaceuticals, biotechnology, distributors, and life sciences and tools posted positive returns while healthcare supplies and equipment, healthcare facilities and managed care performed poorly in the month.

Volatility was the main characteristic of the markets: the S&P 500 broke a seven-week long losing strike, soaring over 6.5% in the last full week of May. The impressive rebound was prompted by economic data that seem to suggest inflation has peaked. It will take a few more months to know for certain that inflation has indeed started to moderate, however we believe the conditions for sustained high inflation could start to reverse.

The Fed and central banks around the world have shifted to a more hawkish approach by raising interest rates and quantitative tightening. Although the impact of a stricter monetary policy is a fundamental tool to bring down inflation, the demand/-supply balance is what ultimately influences inflation in the shorter term. At the height of the pandemic, governments put in place munificent fiscal policies which kept demand artificially high while the global supply chain was the most impacted by lockdowns. The supply side is showing signs of improvement with major Chinese cities reopening and comments from companies that some shortages are easing. More importantly, the reduction in fiscal stimulus is already causing demand to fall fairly dramatically, as shown by the likes of Walmart, Target and Amazon pointing to a weaker consumer trend while being over-staffed and carrying excessive inventory.

Despite the positive development on inflation, there are still a number of unknowns that could affect the macroeconomic landscape. First, new COVID-19 variants could spread again and might cause renewed lockdowns across the globe, distressing supply chains once again. Second, the continuation of the war in Ukraine could impact the availability of various natural resources and commodities, of which it and Russia are large producers (titanium; wheat; oil etc). Finally, and most importantly, the labour market remains tight, with many companies competing to attract and retain staff by offering higher bonuses and wages. If this trend does not reverse or moderate, we could see a wage-led inflation spiral.

Sector review

Switching gears to focus on the healthcare sector, M&A is starting to show signs of life following Pfizer’s bid for Biohaven Pharmaceutical Holding (Biohaven) and GSK’s bid for private company Affinivax. Under the terms of the first agreement, Pfizer will acquire all outstanding shares of Biohaven for $148.5 per share, gaining global commercialisation rights to migraine asset Nurtec ODT, a CGRP receptor antagonist. Biohaven shareholders will also receive 0.5 of a share of New Biohaven, a new publicly traded company that will retain Biohaven’s non-CGRP development stage pipeline compounds. With regards to Affinivax, GSK is set to pay $2.1bn upfront and up to $1.2bn in potential milestone payments, with the intention of gaining access to a next-generation 24-valent pneumococcal vaccine candidate in Phase II trials. Further, GSK believe they are acquiring a potentially disruptive vaccine technology known as MAPS (multiple antigen presenting system).

Fund performance and activity

The Company’s NAV declined by 0.22% in May, modestly behind the MSCI AC World Daily Net TR Health Care Index benchmark which declined by 0.02% for the month (all figures in sterling terms).

Positive contributors were Biohaven Pharmaceutical Holding, United Therapeutics and Envista Holdings. Biohaven’s performance is a direct result of Pfizer’s intention to acquire the asset for a substantial premium, presenting an opportunity to exit the position. On 24 May, United Therapeutics received FDA approval for Tyvaso DPI, an inhalation device for the treatment of pulmonary arterial hypertension. With a clean label, the approval lifts a material overhang from the stock. Envista Holdings performed strongly following a strong set of 1Q22 financial results. More importantly, the company offered upbeat FY22 guidance despite having exposure to China, Russia and Ukraine. A lack of exposure to Roche Holdings was also a positive contributor following a disappointing clinical update from the company’s oncology pipeline.

Negative contributors in May were UCB, Genmab and Horizon Therapeutics. UCB received a negative surprise from the FDA with regards the filing for key asset bimekizumab, for the treatment of psoriasis and a number of rheumatology indications. The FDA issued a CRL (a Complete Response Letter) stating that certain inspection observations must be resolved before approving its application. The clinical data for the asset remain compelling, but in the absence of a more precise approval timetable the shares could struggle in the near term. There was no material news flow in the period for Genmab, but Horizon Therapeutics did report 1Q22 financial results. The results in isolation were fine, but there is a concern that 2Q22 consensus forecast for lead drug Tepezza, for thyroid eye disease, may be a touch high. A lack of exposure to Pfizer was also a drag on performance with the stock performing strongly during the month.

There was modest activity during May, with no new buys but we did take profits in Biohaven and also exited the position in Avadel Pharmaceuticals following a regulatory setback for the company’s lead asset, in development for the treatment of narcolepsy.

Outlook

We continue to believe the healthcare sector has the characteristics to perform relatively well in either a stagflationary scenario or a more classic recessionary environment. As mentioned in previous commentaries, healthcare stocks carry the lowest earnings and price beta to a variety of macro indicators such as GDP, PMIs and CAIs (current activity indicators) and are therefore less exposed to macro challenges. Additionally, demand for healthcare goods and services is inelastic and pockets of healthcare offer reasonable levels of protection from inflationary pressures given they can pass on costs to their customers, are vertically integrated or have high gross and operating margins that can absorb the additional costs. Finally, during periods of prolonged stagflation, quality companies with high cash-flow generation, solid balance sheets and high returns on equity and investments should perform better than higher growth but less cash-generative businesses, whose value is more sensitive to interest rates.

As at 6 June 2022.