This article was originally produced in conjunction with Boring Money for their Investment Trust Hub.

Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved makes any express or implied warranties or representations.

While the technology sector had a bumper year in 2023, the story hasn’t been quite as straightforward for healthcare. However, with attractively low valuations and many high-profile advances in medical technology, all eyes are on whether the industry will be able to outperform again in 2024.

In the last year, the healthcare sector has noticeably lagged behind the broader market. The MSCI World Health Care Index, which tracks the performance of healthcare stocks in 23 developed markets around the world, posted gross returns of +7.77% USD in January 2023 to January 2024. Compare this to the MSCI World Index - which tracks a broad basket of global stocks across different sectors and recorded +17.59% USD over the same period - and it’s easy to see that healthcare has been a good few paces behind.

The story behind healthcare stocks in 2023

The reasons for this are myriad. Edward Yoon, Health Care Portfolio Manager at Fidelity, explains why the healthcare sector was generally less well-received than other parts of the economy in 2023: “Healthcare as a whole simply has not been in favour with investors in the past year. Healthcare stocks tend to be viewed as defensive, given that people generally go to the doctor and take their medications regardless of what's going on in the economy.

“This reputation was a disadvantage in the past year,” he says, “as investors favoured mega-cap growth stocks (particularly those of large tech companies seen as potential plays on artificial intelligence), over defensive sectors. This fueled the sector’s overall lagging returns.”

Demand on healthcare services nears record high

Dive beneath the surface, however, and it’s clear that some subsectors played a bigger role than others in the less-than-stellar performance in 2023. James Douglas, Fund Manager at the Polar Capital Global Healthcare Trust, says: “Managed care, life sciences tools and services, and pharmaceuticals all struggled. The managed care subsector underperformed, with the key concern being increasing medical costs in the face of the rising consumption of product and services as patients and consumers gain access to care.”

Significant progress has been made recently in areas such as Alzheimer’s disease, obesity, early-stage breast cancer, bone marrow cancer, smoker’s cough and hot flushes associated with menopause.

The increasing demand for healthcare services is not an unforeseen phenomenon. Data from the Health Foundation suggests that, in the UK, the number of patients waiting for treatment on the NHS could reach a record high of 8 million by August 2024. NHS England states on its website: “There is a rising demand for health services due to an ageing population with increasingly complex healthcare needs. People are living longer and, as they age, their healthcare needs change.”

Meanwhile, Douglas adds that the life sciences tools and services subsector also struggled in 2023 thanks to a number of factors, including “inventory destocking, a slowdown of activity in China and a biopharmaceutical industry that adopted a more conservative approach to R&D investments.”

Weight-loss winners and pandemic-era losers

While there was more momentum in the pharmaceutical subsector, performance was demarcated between a clear set of ‘winners’ and ‘losers’. Among the winners were Novo Nordisk and Eli Lilly, both of which enjoyed a surge of interest off the back of their innovative new weight loss drugs – Novo's Ozempic® and Wegovy® and Eli Lilly's  Zepbound™ and Mounjaro™. The ‘losers’ included Pfizer, which reported a 41% operational decline in 2023 due to dwindling Covid-19 revenues, and Roche, which saw sales fall 7% over the course of the year.

This industry-wide volatility in turn drove down valuations, impacting firms across a range of different subsectors, including life sciences and tools and managed care. Stocks in these areas were hit when new regulations lowered enrolment and reimbursement rates for healthcare insurance for millions of customers in the United States.

High-profile breakthroughs hit headlines

However, there were some success stories that should not be overlooked, Douglas says, such as the biopharmaceutical industry.

“This subsector of healthcare really has been at the forefront of delivering innovative breakthroughs designed to tackle highly unmet medical needs. Significant progress has been made recently in areas such as Alzheimer’s disease, obesity, early-stage breast cancer, bone marrow cancer, smoker’s cough and hot flushes associated with menopause – and this is by no means an exhaustive list.”

So it wasn’t a wholly bad year for healthcare, but many of the ‘good’ news stories are yet to be reflected in investor sentiment towards the sector as a whole. Douglas concedes that healthcare stocks entered 2024 “heavily out of favour”. However, this very fact gives way to an exciting investment opportunity, according to a growing proportion of investors and industry analysts.

How healthcare is primed for better performance in 2024

Looking ahead into this new year, there are signs that healthcare stocks have all the makings to achieve better results. This is rooted in strong fundamentals with steadily rising demand, contracted valuations and a stream of high-profile breakthroughs attracting attention from retail and institutional investors alike.

AI and other technologies offer the potential to personalise patient interactions, streamline administrative and care processes and free up clinicians to focus on complex procedures.

With waiting lists in the UK nearing record highs, and utilisation globally continuing its upward trend since the pandemic, this environment could prove to be a solid foundation for growth throughout 2024. After all, data suggests that more people are in need of more healthcare services than ever before – a phenomenon that is essentially global in its scale.

This growing demand benefits large swathes of the healthcare sector, of course, but some more than others. “While the uplift in utilisation is broad-based,” Douglas explains, “various pockets within the industry are set to grow faster, driven by durable trends such as shifting patient volumes out of hospitals into outpatient settings, robotic surgery, behavioural health and the continuous monitoring of key indicators of health.”

AI advancements expected to benefit healthcare

Indeed, the very same hype around AI which made tech stocks all the rage in 2023 has begun to permeate through to the healthcare sector too. In its 2024 Global Healthcare Sector Outlook, consultancy firm Deloitte noted that the recent surge in interest and investment in artificial intelligence (AI) poses multi-faceted opportunities for healthcare firms in the years ahead.

“In the wake of the COVID-19 pandemic, healthcare systems worldwide are embracing emerging technologies to address ongoing challenges, including cost reduction, improved access to care and a shortage of skilled workers. AI and other technologies offer the potential to personalise patient interactions, streamline administrative and care processes and free up clinicians to focus on complex procedures.”

Lower valuations make for a rare window of opportunity

And while there is scope for further innovation and growth, many healthcare stocks have entered 2024 with compressed valuations thanks to the volatility seen throughout last year. At the Polar Capital Global Healthcare Trust annual general meeting in January, Gareth Powell, Head of Healthcare at Polar Capital, pointed out that the S&P 500 Health Care Index – which tracks a broad basket of US-listed healthcare stocks - was operating at “a 10-15% discount to the long-term average, which [they] see as a decent opportunity in terms of offering upside for healthcare”.

Beyond this, the exceeding popularity of new weight loss drugs such as Ozempic® and Zepbound™ - classified as glucagon-like peptide 1 (GLP-1) agonists – continues to draw attention for their potential for widespread usage both to treat conditions such as diabetes but also to manage obesity. So great is the demand that Novo was forced to ration supplies in Europe in November 2023, warning of intermittent shortages throughout 2024.

Andy Acker, Portfolio Manager on the Health Care and Biotech Teams at Janus Henderson Investors, states in a December article: “We believe GLP-1s could be the biggest market opportunity yet in biopharma, with sales topping $100 billion before the end of the decade.”

The verdict on what lies ahead

So despite a lacklustre performance in 2023, the general consensus is that healthcare stocks will rebound in the near-term. In a January article, Douglas was keen to emphasise the resilience of the sector in the face of numerous challenges, and that it has all the makings of a recipe for success in 2024.

“There is a huge amount we are engaging with and are excited about,” he explains. “The demand for healthcare products and services remains strong, cutting-edge innovation is yielding solutions that address hitherto unmet medical needs and the industry continues to consolidate.

“All this sits on a backdrop where healthcare is heavily out of favour, is attractively valued and is demonstrating an ability to deliver consistently attractive revenue and earnings growth, regardless of the economic, political and regulatory environment. It is these characteristics that fuel our optimism for the year ahead.”