As we entered 2022, global markets reflected a sense of optimism for stability and continued economic recovery following the historic volatility witnessed throughout 2020 and 2021 as a result of the COVID-19 pandemic; however, 2022 proved far more turbulent than expected.
Multiple adverse events affected global markets and the economy as they continued to grapple with a persistent COVID-19 environment. These incremental headwinds included Russia’s invasion of Ukraine and supply chain issues that exacerbated surging inflationary pressures. Central banks were forced to pivot to aggressive monetary tightening, which weighed on investor sentiment and triggered mounting fears of a global recession.
There were few places to hide in this challenging environment, as broader equity and fixed-income markets experienced steep losses. Yet the healthcare sector offered relative protection during the drawdown, once again proving its reputation as a defensive space for investors.
Notwithstanding the sector’s relative outperformance in 2022, we believe that healthcare remains an attractive investment in 2023 and over the long term. The sector’s resilient qualities should help it outperform the broader equity market through a full market cycle while its propensity for groundbreaking innovation is likely to provide strong growth avenues.
While COVID-19-related advancements have been the focus of the healthcare landscape recently, the pursuit of treatments and advancements for other unmet medical needs remains a core focus of the industry. These include cancer, metabolic syndromes, rare or orphan diseases, and central nervous system (CNS) disorders. Furthermore, emerging evidence of the health outcomes of patients previously infected with COVID-19 increases the importance of addressing such unmet medical needs.
Indeed, the ability of healthcare companies to address such unmet medical needs is one of the three guiding principles by which we allocate capital and helps inform the sector’s impressive long-term growth prospects moving forward.
Investment growth for every US$100,00 (December 31, 1994─December 31, 2022)
Global healthcare equities have outperformed the broader market by over 3% (annualized) since 1995
Source: eVestment, as of December 31, 2022.
Healthcare’s resilience throughout the economic cycle
The healthcare sector has historically delivered strong outperformance throughout economic cycles, particularly during downturns. These excess returns tend to be more pronounced during periods of heightened market volatility and economic distress. The challenging environment experienced in 2022 was no different, with the sector delivering strong relative excess returns.
Healthcare sector: relative excess returns are more pronounced during economic downturns
Source: eVestment, as of December 2022.
The sector’s defensiveness stems from the supply-and-demand dynamic of healthcare products and services. While cyclical industries usually experience a sizable reduction in demand during economic downturns, healthcare demand generally remains resilient, with consumers having an inelastic appetite for biopharmaceutical products and medical goods and services. This was even more pronounced during the pandemic, with many healthcare products and services experiencing a surge in demand.
While it’s uncertain whether we’ll see a major global economic recession in 2023, we expect the healthcare sector to offer investors a relatively safe place for their capital if a recession ultimately occurs.
The long-term impact of the pandemic remains a concern due to post-COVID-19 public health implications
Our fundamental research process has uncovered several noteworthy clinical trials demonstrating increased morbidity in patients recovering from previous COVID-19 infections (so-called long-COVID). These studies have specifically identified the elevated risks of cardiovascular diseases, diabetes, and CNS diseases among patients who have had COVID-19 previously (relative to the uninfected population).
While the long-term implications of these findings will require further research, we believe the consistency of these findings (from multiple researchers) implies increased underlying demand for relevant biopharmaceutical and medical products in a postpandemic world.
Opportunities for innovation strengthened by the pandemic
In recent years, COVID-19-related advancements have been the focus of the healthcare landscape. The world’s leading healthcare companies developed effective vaccines, diagnostic tests, and therapeutics to combat the virus in record time. In addition, new technological advancements in telehealth allowed doctors to connect remotely with patients as the pandemic spurred innovation across the industry.
While most of the world is seeing lower hospitalizations, deaths, and improvements in treatments for the virus, Mainland China and certain other territories have seen a surge in cases; we expect these fluctuating spikes to continue in various geographies as COVID-19’s transition to a seasonally endemic virus plays out.
The remarkable response of the healthcare industry to the pandemic has generated incremental returns due to sales of the vaccines, diagnostics, and therapeutics mentioned above. As anticipated, many of these companies have, in turn, reinvested excess cash flows to augment their discovery capabilities, capital spending, and pipeline investments, therefore aiding further advances in non-COVID-19 unmet medical needs.
As we transition to a post-COVID-19 environment, we expect innovation to accelerate across the sector and believe it’s poised to reap the rewards of these incremental investments.
Implications for investment outlook
Rigorous fundamental research that sifts through vast swathes of scientific data is paramount when allocating capital to this sector, in our view. A bottom-up fundamental investment process informed by the assessment of emerging scientific and medical developments, coupled with a disciplined intrinsic valuation framework, has the potential to uncover robust opportunities for investors at fair valuations.
This approach continues to inform how we evaluate investment opportunities across the healthcare universe. To this end, structural changes in healthcare—including, but not limited to, long-COVID—support the urgency to effectively manage other preexisting disease states (e.g., cancer, metabolic syndromes, asthma, and other immunologic disorders) that our research suggests may predispose these comorbid patients to higher morbidity and mortality due to COVID-19. Accordingly, this has led us to increase our conviction in biopharmaceutical companies that are over indexed to cardiovascular disease, Alzheimer’s, and diabetes at the present time.
Second, we maintain a positive view on several diagnostics and tools companies as well as biopharmaceutical firms that we believe will continue to reap the benefits of excess cash flows consistent with the emerging endemic state of COVID-19. We believe several of these names will generate above-market returns as the incremental research, capital spending, and pipeline investments they’ve implemented reach fruition.
For example, a diversified healthcare product company has invested substantial incremental profits from its COVID-19 testing business to advance its market-leading position in continuous glucose monitoring—an emerging diagnostics modality and underappreciated market opportunity in type 2 diabetes.
Finally, we have a negative view toward select biopharmaceutical, healthcare services, and medical device companies that are over indexed to various disease states and product markets disproportionately as well as had been adversely affected by the persistent COVID-19 environment. These include companies with exposure to elective surgeries, hospital services, and select oncology conditions.
Secular trends warrant a long-term allocation to healthcare companies
We believe that new modalities in treatment and prevention will continue to drive long-term governmental outlays toward healthcare products and services. Irrespective of the incremental tailwinds and headwinds associated with COVID-19, the underlying secular trends of aging demographics, medical advancements, and profound unmet medical needs continue to support long-term exposure to global healthcare companies in a well-balanced investment strategy.
Select companies within the healthcare space offer the potential for strong, long-term outperformance. As such, this could be an opportune time to invest in the sector, with a focus on the importance of stock selection as a potential driver of outperformance. We believe these innovative and compelling companies can survive the next market downturn and create long-term value for shareholders.
In our view, a bottom-up fundamental investment process informed by assessing emerging scientific and medical trends, coupled with a disciplined intrinsic valuation analysis, can uncover these robust opportunities. This approach should ensure that capital allocation focuses on companies that are tackling important unmet medical needs, pursuing underappreciated market opportunities, or have demonstrated an ability to bend the healthcare cost curve.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
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