«Healthcare sector’s risk/reward profile should resonate more powerfully»

15.10.2021

Mr. Cianflone, how has healthcare performed recently?

September certainly lived up to its reputation for seasonal weakness. The MSCI World erased its 5 percent intra-quarter gain to finish roughly where it started and still up 13.0 percent for the year. In similar fashion, large-cap healthcare shed most of its intra-quarter gains, ending up 1.0 percent, and 11.0 percent for the year. The Q3 strength in medtech (+4.3 percent) offset the weakness in services (-2.4 percent), while biotech and pharma finished +1.2 percent and -0.4 percent respectively. Small- and mid-caps continued to underperform, as the Russell 2000 and Russell 2000 Healthcare fell 4.4 percent and 10.6 percent over the last three months. Meanwhile, the MSCI Emerging Markets (EM) shed 8.1 percent, dragging its year-to-date performance to 1.2 percent. EM Healthcare was particularly weak, slipping 13.0 percent in Q3 and -5.3 percent year-to-date.

What are the main market risks?

There are many variables to consider in today’s market, reflecting serious concerns about inflation, the prospect of stagflation, and the potential for policy errors advanced by politicians or central bank officials. Consider just one notable example, the US Federal Reserve, where a potential taper tantrum and the timing of «lift-off,» two surprise retirements, and a potential chairmen succession could destabilize global economies. Other possible market shakers include China’s Common-Prosperity initiatives and President Xi Jinping’s third-term election in the fall of 2022, the US Democrat’s massive «Build Back Better» and infrastructure bills - including their «zero-cost» tax increases -, and the 2022 midterm elections, which could radically alter the US political landscape.

What scenario do you expect in the coming months?

In the worst-case scenario, the global economy may buckle under the stress of supply-chain and energy bottlenecks. There could also be pandemic-related hiccups, which track along an equilibrium trajectory that falls short of 2019 run-rates, a precarious situation in which the political fallout could be far worse than any economic or financial measure.

Alternatively, in the best-case setting, we may exit 2022 with the pandemic slipping behind us and a more efficient economy lighting the horizon, thanks to the rapid adoption of various new technologies and a substantial supply-side pick-up, one that serves more rational demand. These developments would enable the global economy to better carry its enlarged debt burden.

Although the actual outcomes should fall somewhere between the two extremes, and likely will skew to the positive, the market must discount the range today, and then hope for the best.

How do you see healthcare performing in this market environment?

Healthcare is well equipped to weather the storm. For most of the companies we follow, demand is primarily inelastic, supply is typically prioritized - although not immune from stresses -, and funding is relatively stable. Most important, the sector has responded rapidly and impressively to the pandemic’s call-to-arms, delivering to the world breakthrough vaccines and oral anti-viral medications, the next great additions to the global pharmacopeia. Covid-19 has underscored healthcare’s importance, its flexibility and capacity for innovation. The sector’s essentiality underpins our view that a return to its traditional premium to the overall market seems inevitable over time. Over the last twenty years, the MSCI World Healthcare has traded at average and median premiums to the MSCI World of roughly one multiple-turn on a price-to-next-twelve-month-earnings basis. Currently, the sector trades at a single turn discount to the MSCI World, despite superior anticipated earnings growth in healthcare. With the re-open trade now fading into a late-cycle pattern, the sector’s risk/reward profile should resonate more powerfully. Therefore, we anticipate that allocations will increase accordingly in the future.

What are your current investment preferences in healthcare?

Our preference remains for a balanced approach across healthcare sub-industries. In biopharma, fears over radical US drug-pricing legislation look increasingly overblown, while value-creation opportunities, including important data releases and early signs of an M&A resurgence, abound. Although medtech and services are not immune to such short-term disruptions as the emergence of viral variants, we see great opportunity in novel and enabling technologies, both in the near-term and over time. In emerging markets, our focus remains on best-in-class companies offering local-market domain expertise, as these players provide some protection against political winds. As investors have all but abandoned small- and mid-cap healthcare during 2021, so far, we are capitalizing on short-term pricing anomalies.

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