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Why and how to invest in the healthcare sector

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Written by: Paloma Kubiak
01/02/2016
We look at why and how to invest in the healthcare sector, whether investors should consider specific stocks or funds, and whether there is a move towards biotech over traditional healthcare.

Healthcare in context

People will always get ill and death is inevitable. With ageing populations, healthcare needs are only going to increase. So the long-term opportunities for investing in this space look good.

The cost of healthcare is an issue, one governments can’t solve alone. Companies that make things more efficient, productive or cheaper, either in the form of services or products, should do well.

The potential for merger and acquisition activity is a positive and has been a key trend over the last few years, says Rob Morgan, pensions and investments analyst at Charles Stanley.

“I expect it to be a decent year for M&A and given the recent sell off in the sector it could be an interesting entry point for the long-term,” he says.

“There’s strong demand for pipelines of future drugs and therapies from larger pharmaceutical companies that are often keen to buy up smaller and medium-sized companies with promising products.”

Focusing specifically on 2016, healthcare will be defined by how successful research is and how development pipelines progress at an individual company level, Morgan says.

The ageing population and increasing obesity is fuelling demand for well-funded research and development, and fund managers are reporting R&D-focussed stocks at attractive valuations.

However, promising discoveries don’t always translate into commercial success, as seen last year with Sunesis’ lead leukaemia product Vosaroxin, which disappointed at the third phase of testing.

The failure in drug trials, along with “risk aversion” among investors and changes to regulation in terms of patents can all have a negative impact on the healthcare sector.

Preferred funds and investment trusts

Investors looking to tap into healthcare can either look at specific stocks – either directly or via a pure healthcare fund – or opt for a general fund, which has high exposure to healthcare companies.

For the more bullish healthcare investor, Darius McDermott, managing director of Chelsea Financial Services, likes the open-ended Polar Capital Healthcare Opportunities fund and the closed-ended Polar Capital Global Healthcare Growth and Income Trust. These are run by the same manager, Gareth Powell, who previously worked in the healthcare industry.

McDermott says the open-ended fund is the riskier of the two as it invests in more biotech – currently 25% compared with just 6% in the investment trust.

Morgan tips the Worldwide Healthcare Trust for exposure as it owns a relatively diversified portfolio of 60-70 pharmaceutical firms as well as some biotechnology companies. He says the managers, OrbiMed Capital, are one of the leaders in the field of healthcare and biotechnology investment.

Adrian Lowcock, head of investing at Axa Wealth says there’s limited choice in the healthcare space but picks AXA Framlington Health, which is predominantly invested in large cap companies.

For investors taking a broader approach but with a strong bias towards healthcare exposure, McDermott, Morgan and Lowcock all tip Neil Woodford’s Woodford Equity Income fund as the manager currently has a 34.5% overweight position in the healthcare sector. However, Lowcock suggests putting no more than 1-2% of your overall pot of money into the fund.

McDermott and Morgan also like the closed-ended Woodford Patient Capital Trust as it invests in young, immature companies.

Morgan also plumps for Edinburgh Worldwide Investment Trust which includes exposure to innovative healthcare and biotechnology firms.

Individual stocks 

Morgan says investing in single stocks is a riskier approach as it is hard for individuals to replicate the diversification offered by a fund. However, he adds that scientific and technological innovations in healthcare have the potential to reward brave investors. The caveat is that there is a high failure rate of smaller biotech companies that only develop a small number of drugs.

In contrast, McDermott says investors could easily go for FTSE 100 options such as AstraZeneca or GlaxoSmithKline which have the added appeal of paying a dividend. He notes it’s harder to invest in smaller healthcare companies as many aren’t listed, so a fund may be a better option.

Steve Clayton, head of equity research at Hargreaves Lansdown, chose a healthcare stock as one of his five stocks to watch in 2016.

“Economies can blow hot or cold, but people will still get ill and healthcare providers will be seeking efficiencies regardless,” he says.

His pick is EMIS Group plc (EMIS), which is listed on the AIM market, currently valued at £675m, and it has grown profits every year since 2010, accompanied by rising dividends.

Other ways to invest – passive funds

If passive investing is your preference, there are a number of tracker funds on the market. The healthcare sector is full of a broad mix of companies in different stages of development and at varying valuations so a tracker will give you exposure to a sample of this, says Morgan.

McDermott and Morgan both suggest Legal and General’s Global Health & Pharmaceutical Index, given its low 0.31% ongoing charge figure (OCF).

Another pick from Morgan is global tracker db X Trackers MSCI World Health Care TRN Index.

Biotech vs traditional healthcare

Biotechnology is part of the broader healthcare sector and is the use of living organisms to develop or make products such as medicines. It uses cutting edge scientific techniques, which often means a high level of investment is required and several rounds of research. Some products can fail while commercial success is possible for companies that discover new drugs.

Lowcock says: “Biotechs have been on a bit of a roll over the last few years as valuations rocketed and the sector benefited from M&A. While this is likely to continue into 2016, investors should be wary as at some point this trend will reverse. Large pharma has struggled more in 2015 as concerns over patent cliffs and future earnings growth weighed on the sector.”

However, he says 2016 is seen by some as the turning point for many pharmas, where earnings growth is expected to pick up again. While M&A activity will mean biotechs remain in the headlines, small investors could easily get caught out by a sudden change in sentiment.

McDermott and David Pinniger, biotech fund manager at Polar Capital, also agree that investors often have a crisis of confidence when it comes to biotech, although the sector does tend to bounce back.

Pinniger says: “The cost of healthcare is an issue, so companies that can make things more efficient/productive/cheaper and help solve the problems either in the form of services or products should do well. With aging populations, healthcare needs are only going to increase, so the long-term opportunities are great.”

For Morgan, investors who want pure exposure to biotechnology – the more risky option – could opt for The Biotech Growth Trust, which is run by same team as Worldwide Healthcare Trust.

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