Stockholm (HedgeNordic) – The healthcare sector has long been considered a reliable defensive sector in a portfolio. 2022 was a case in point. The sector’s defensive qualities stem from the stable and growing demand for its products and services almost regardless of how the broader economy develops. The sector also combines its near-term defensive characteristics with longer-term growth attributes coming from long-term secular tailwinds such as rising standards of living and an aging population.
“People get ill independent of economic environment. Both chronic and acute illnesses have to be addressed no matter the economic outlook,” explains Susanna Urdmark, co-chief portfolio manager at Rhenman & Partners. “This creates a floor of stability for the industry that absorbs some volatility throughout economic cycles,” she elaborates on the industry’s defensive attributes.
“People get ill independent of economic environment. Both chronic and acute illnesses have to be addressed no matter the economic outlook.”
The industry’s growth attributes, meanwhile, come from a range of factors such as innovation, and product development, among others in response to secular trends such as aging populations. “Demographic trends support the continued volume growth of the industry and also the need for innovative therapeutics and technologies, which we believe will translate into incremental value creation,” argues Urdmark. “Part of our job is to look for companies and sectors that create additional growth and contribute to that incremental value creation.”
Different Dynamics Across Sub-Sectors
The broader healthcare industry is made up of multiple sub-sectors that do not move in tandem and form a desynchronized ecosystem. Each sector can be affected differently by rising interest rates, labor costs, supply chain issues, economic slowdowns, or other macroeconomic trends. Flexible and active asset managers with expertise in the industry can incorporate these dynamics into building a portfolio that maximizes the industry’s defensive nature, while also positioning for growth as economic conditions improve. “Healthcare as a whole is quite a diversified sector and the different areas can perform differently in various economic environments,” explains Urdmark.
“Healthcare as a whole is quite a diversified sector and the different areas can perform differently in various economic environments.”
“We have the possibility to allocate capital into different sub-sectors to a different degree over time depending on our top-down market assessment,” elaborates Urdmark. Individual sub-sectors were impacted in different ways by last year’s economic environment. “Most companies have been able to adjust their pricing to compensate for inflation on the cost side,” says Urdmark. Although the healthcare sector as a whole is not that highly valued, the higher interest rates as a result of central banks’ efforts to combat inflation primarily impacted the valuations of richly valued companies, according to Urdmark.
While the long-biased healthcare-focused fund under the umbrella of Rhenman & Partners tends to invest in smaller, higher growth-oriented companies over time, “last year we started to have a more ‘wait and see’ attitude, waiting for better times” by investing in more boring, larger-cap stocks with defensive qualities, according to Henrik Rhenman.
As Urdmark explains, small-cap biotech companies are the most vulnerable to slowing economic growth and rising rates, as these companies rely on capital markets to sustain future development. Rising rates and risk-off sentiment can put funding at risk. “After the banking crisis in March, the loss-making smaller-cap companies are struggling the most, as there is an increased risk to face difficulties in raising funds going forward.”
“Last year we started to have a more ‘wait and see’ attitude, waiting for better times.”
“Adjusting the allocation between different sub-sectors is just one tool that we have available to us,” says Urdmark. The team running Rhenman’s healthcare fund can also adjust the gross and net equity exposure as market conditions change. “When the Ukraine war started last February, we decided to lower our gross and net exposure because we were not sure what was going to happen,” recalls Henrik Rhenman, the founder of Rhenman & Partners. “It was genuine uncertainty and we have not come out of that somewhat more cautious positioning.”
“We reduced our exposure, not because of the implications of the war itself on the broader economy, but because the war broke out in the early stages of a broad-based recovery that was hindered by inflation and interest rates,” explains Rhenman. “As long as we are not super convinced that we have a full recovery, we will continue to maintain a more cautious stance with a lower exposure.” The team, however, is on the lookout for signs of improving market conditions to re-position the portfolio. “You certainly want inflation down! As inflation comes down, interest rates go down, equity premiums go down, growth prospects go up and financing issues become more predictable.”
Learnings from COVID-Years and Most Exiting Areas
From a top-down perspective, the long-term drivers that have supported the healthcare sector over decades – aging populations, growing spending on healthcare, and technological innovations – remain largely unchanged. The coronavirus pandemic, in particular, proved the ability of the healthcare sector to innovate and create value for society and investors. “We always knew that there was this room for innovation in the healthcare industry,” says Susanna Urdmark. “What surprised us was the speed by which that innovation happened with the speedy development of the vaccines, the antivirals, and other therapies that helped patients.”
“We always knew that there was this room for innovation in the healthcare industry.”
“Perhaps an even greater achievement was the fact that these companies could maintain focus on the other development programs as well,” emphasizes Urdmark. “All other development programs did not come to a complete stop when the focus was put on developing treatments needed to deal with the acute situation coming from the pandemic,” she elaborates.
One area of the healthcare sector that experienced a huge leap of innovation in recent years has been obesity treatment. Eli Lilly, Amgen, and Pfizer are just some of the companies aiming to compete with Danish insulin producer Novo Nordisk in a new generation of weight-loss drugs. “We have about ten percent of the fund’s exposure towards obesity treatment,” points out Rhenman.
“Since the beginning of the year, we have told our investors that this is the year we should keep our eyes on what is going on in obesity and Alzheimer’s as several new launches are lined up in these areas,” says Urdmark. Obesity treatment, for instance, has a huge addressable market “with a great medical need, very few treatment options in existence, and an abundance of new clinical data that will be presented throughout the year,” she elaborates. The obesity treatment market is expected to grow from a $2.4 billion category in 2022 to $54 billion by 2030, according to Morgan Stanley Research. “We are very encouraged by the determination of the industry to continue to innovate even in the most difficult situations.”
This article features in HedgeNordic’s Nordic Hedge Fund Industry Report.