Stockholm (HedgeNordic) – With commodity prices soaring due to growing pressure on Russia in response to the invasion of Ukraine and with central banks belatedly responding to already high inflation stemming from the pandemic, many market participants are concerned about the world heading back to the 1970s “stagflation” environment. While nothing is recession-proof, the healthcare sector has historically proved to be relatively insensitive to economic fluctuations.

“Healthcare was a sector that outperformed during the stagflation period in the seventies and it is quite easy to understand why,” says Henrik Rhenman, who co-manages Rhenman & Partners’ healthcare strategy together with Susanna Urdmark. “Economic growth may be slowing down, but healthcare is always in demand,” he adds. Health services, after all, are in need even during a recession. “Additionally, the sector has somewhat higher pricing power than most sectors,” elaborates Rhenman. “I wouldn’t say healthcare is the sector with the strongest pricing power but it is certainly better than average.”

“Healthcare was a sector that outperformed during the stagflation period in the seventies and it is quite easy to understand why. Economic growth may be slowing down, but healthcare is always in demand.”

“Stable demand for healthcare and reasonable pricing power makes the healthcare sector a less risky place to be during an uncertain and stagflationary environment,” concludes Rhenman. Susanna Urdmark goes on to emphasize that the healthcare industry and its participants face fewer headwinds from the surge of commodity prices, even though non-commodity-related input costs such as wages, rents, and others are also on the rise.

“The inflationary pressures on input costs coming from higher commodity prices are significantly lower in this sector compared to others.”

“Compared to many other sectors, healthcare is less vulnerable to soaring energy prices and commodity prices,” says Urdmark. “The inflationary pressures on input costs coming from higher commodity prices are significantly lower in this sector compared to others.” Urdmark also points out that in many markets, healthcare consumers face a less heavy financial burden due to potentially higher health care costs because of their limited out-of-pocket spending.

Source of Attractive Returns

Although investors frequently look to the healthcare industry for its defensive nature, fewer investors may think of it as a sector with significant potential to generate growth and returns. However, this industry offers investors the opportunity to invest in companies that are constantly innovating to improve quality of life, raise productivity and similarly, generate attractive returns on investments. Since its launch in mid-2009, Rhenman & Partners’ fund has proved that the healthcare industry is full of return-rich opportunities and exhibits strong return potential.

“We are confident that by setting a realistic goal of 12 percent, we can have a good chance in achieving that in most types of environments, as long as we are nimble and realistic in our stock picking.”

“When we started the fund, we set out a goal of achieving a 12 percent annual return after fees over time,” says Rhenman. The long-biased long/short equity fund has managed to deliver an annualized return of 18 percent since inception through the end of March 2022. “We are confident that by setting a realistic goal of 12 percent, we can have a good chance in achieving that in most types of environments, as long as we are nimble and realistic in our stock picking,” he emphasizes. “One could say that we have set a goal that is too easy, considering what we have been able to achieve, but it is very important that we do not take on more risk if we are in an environment that is less generous to our type of investment style and our sector.”

Strong Expertise and Experience Required

“We see healthcare as a very exciting sector, where we forecast structural growth for the foreseeable future, and believe that, through the right kind of diversification, we can offer our investors attractive returns at a risk level that is manageable,” corroborates Urdmark. “The strong performance of the sector is really explained by the medical advances that we have seen over the past 30 years or so, and the formation and evolution of the biotech sector have been driving this development,” she elaborates. However, successful healthcare investing does require expertise, skill and effort. “Especially within biotech, but also within the broader industry, successful investing requires a high degree of knowledge and experience to manage and achieve a good balance between risk and reward.”

“We see healthcare as a very exciting sector, where we forecast structural growth for the foreseeable future, and believe that, through the right kind of diversification, we can offer our investors attractive returns at a risk level that is manageable.”

Although the Rhenman & Partners investment team has accumulated decades of experience in the healthcare industry, with Henrik Rhenman originally a biochemist before embarking on his asset management career and Susanna Urdmark following the sector as an analyst and working as CFO for a Swedish pharmaceutical company, the team has created an additional source of expertise. On a quarterly basis, Rhenman and his team have been meeting their Scientific Advisory Board, composed of well-established practicing medical experts with their own large network of researchers and specialists, to gain insights and understanding of new drugs, techniques, treatment methods and clinical trials.

“We are preparing a solid agenda of some 20 different company- or scientific-specific questions that we bring to the Advisory Board every time we meet,” explains Urdmark. “We meet and sit down in this forum to discussdifferent topics, which helps us either get a clear signal that this idea is really interesting or has potential, or this is too early,” she elaborates. “Sometimes we may even hear that the board just does not like what we thought they would like, but this process helps us calibrate the risk-reward of our investments and take on the right level of risk matching the reward.”

Cautiously Positioned

The team predominantly relies on a bottom-up analysis process to turn its $1 billion in assets under management into an attractive risk-reward portfolio, with this process considering a wide range of fundamental aspects, future prospects and valuation levels. “Our selection is very much bottom-up, but we have a top-down overlay at all times,” says Rhenman. “Our actual portfolio construction is all about selecting good companies that have good prospects, making good progress and generating attractive returns on their investments, but we always have to consider the macro environment.”

“Our selection is very much bottom-up, but we have a top-down overlay at all times.”

Of late, the environment in which all fund managers including Rhenman & Partners Asset Management operate has become more uncertain with a worsening geopolitical and macroeconomic outlook followingRussia’s invasion of Ukraine. “The main question on top of our minds is how do we deal with this uncertainty right now,” says Rhenman. “And the answer is that we are careful, we are cautious,” he elaborates. “We are more risk-averse than usual and we are very humble. There is no way we can outsmart the markets in terms of interpreting the next initiative from Russia, Ukraine or other parties. It is very difficult to predict how the war will play out and we are not even trying to.”

This cautiousness, stemming from the uncertain geopolitical and macroeconomic environment as well as the November congressional midterm elections in the United States, has been reflected in the team’s portfolio construction. “In a US election year, the healthcare-focused corner of the stock market usually becomes more constructive after the elections,” explains Rhenman.

“Healthcare will always be political, not political at all times, but the political narrative on healthcare goes in waves,” he elaborates. “We are likely to have a calmer situation after the November elections and that is going to support the generalists, coming back for exposure in the healthcare sector.” With the Republican Party expected to take control of at least one of the houses of Congress, the healthcare industry should enjoy an additional wave of investor demand as a division of power makes it more difficult to push through major policy changes affecting the industry.

“If we take the geopolitical risk aside, the outlook for the sector is very strong.”

“If we take the geopolitical risk aside, the outlook for the sector is very strong,” sums up Urdmark. “Even though we are risk-averse in this environment, and we wish there was a better sentiment for the biotech industry, which has been an important source of returns over the years, there are still great companies doing innovative research with high return potential,” she continues. “We see a better risk-reward in large-cap companies, in particular global pharmaceutical and health services sectors, which are better shielded from these macroeconomic uncertainties and other uncertainties that we have to consider.”

This article features in HedgeNordic’s “Nordic Hedge Fund Industry Report.”