BB Healthcare Trust has announced its annual results for the year ended 30 November 2018. During what the trust’s chairman, Professor Justin Stebbing, describes as “another successful year”, the trust provided Nav and share price total returns of 24.0% and 21.6% respectively. These returns are ahead of the MSCI World Healthcare Index, which it says returned 18.0%. The investment managers point out that this was “despite very challenging macro conditions in the last two months of the financial year”.
Investment Manager’s commentary on performance
The healthcare sector again delivered a superior return to the UK’s FTSE All Share Total Return Index, which declined 1.5% during the year, and the wider global marketplace, which delivered only a 6.1% positive return. The Company’s total return for shareholders was lower than the NAV return because the shares were trading at a premium to NAV of 2.9% at the beginning of the year, versus 0.9% at the end, representing approximately a 2% drag on the total return. Over the year, the average premium to NAV was 1.2% (versus 2.4% over FY2017).
In our opinion, the year can be broken down into three periods; the challenging early months of calendar 2018 (BBH share price low of 101.5p), the six months from April to September (BBH share price high of 150.5p) and then another challenging period from the end of September.
We were somewhat caught by surprise in the early part of the year. We had concerns over valuations and consensus expectations in certain areas following the third quarter of 2017 reporting season, particularly in Large-Cap Biotechnology and Specialty Pharmaceuticals. We thus exited a number of positions toward the end of calendar 2017 (spanning the end of the previous financial year and the beginning of this one). December 2017 saw a painful ‘growth into value’ transition that hurt some of our medical technology holdings and, as the chart in the Annual Report illustrates, early January unexpectedly saw a pronounced (but short-lived) rally in Large-Cap Biotechnology stocks, spurred by hopes of tax reform-fuelled mergers and acquisitions (“M&A”). This hurt our relative performance over this period.
With the provenance of hindsight, these changes to the portfolio were absolutely the right thing to do. The NASDAQ Biotechnology Index rose more than 11% in January 2018 but had fallen back nearly 15% by April 2018, as it became clear that the uncertain environment was dissuading boards from committing to widespread deal-making.
Compounding this unfavourable positioning, the period from January 2018 to mid-April 2018 saw the highest cumulative negative translation impact of our predominantly US dollar-denominated portfolio into a sterling NAV (the benchmark is composed of around 60% US dollar-denominated assets, versus our portfolio being consistently greater than 90% US dollar-denominated). Sterling hit a high of US dollar 1.43 in mid-April 2018, a level not seen since the European Union referendum in 2016. This appreciation in sterling was driven by some short-lived but ultimately forlorn hope of positive progress regarding Brexit.
Setting currency (and the dreaded B-word) aside, the period from April 2018 through September 2018 was relatively benign in terms of macro-political developments. Even though it was dominated by the looming US mid-term elections, global markets made slow, but steady upward progress. In such an environment, strong operational performance was well rewarded and the portfolio made steady progress through to the end of September 2018.
As we have noted in our factsheets, it was not our belief throughout this period that the valuations of our holdings felt elevated when considered against their medium-term growth prospects. Nonetheless, the market can often be both very short-term and much less fundamental/rational when it comes to the determining factors that drive sentiment toward individual stocks. October 2018 brought a significant market correction that has continued to haunt investor confidence since and the levels of volatility that we have seen in both our holdings and the relevant currencies has been unprecedented versus the prior two years of the Company’s life.
Through the October-November 2018 period, the Company’s NAV declined 6.1% in absolute terms, substantially underperforming the benchmark. The best performing healthcare assets during this period were the blue-chip large-cap pharmaceutical companies, which we are highly unlikely to own since they are antithetical to our strategy. The healthcare benchmark is highly weighted to such companies and this compounded our relative underperformance.
In general, the factors driving the market have been top-down (i.e. macro-driven) rather than bottom-up and stock picking has taken something of a back seat to sub-sector asset allocation. Put simply, the only thing (apart from hiding in cash) that really worked from the end of September 2018 was low beta and ‘value’ oriented approaches.
The table below shows the performance of the benchmark by sub-sector across our financial year. In many ways, the table epitomises the oddities of the year, in the sense that the more utility like sub-sectors with predictable demand drivers but less opportunity for accelerating returns (Managed Care, Services, Facilities and Tools) have fared the best. This is in contrast to Diagnostics, Healthcare Technology/IT, Biotechnology and Specialty Pharmaceuticals, which amongst our holdings we characterise as the innovative end of the spectrum and where we see the most opportunity for outsized returns in the longer-term.
|MSCI World Healthcare Index performance by sub-sector|
|As at 30 November 2018||Weighting||USD Performance||GBP Performance|
Indeed, we felt strongly that the market reaction through October and November 2018 in some of the more NASDAQ-linked sectors like Medical Devices, Biotechnology and Diagnostics was irrational and offered a significant opportunity. We thus instituted a formal equity raise that closed just after the financial year end and increased our use of leverage, to close the period with a gearing ratio of 10.2% (having had an average gearing ratio of 6.1% across the financial year). We also raised capital steadily across the year through tap issuance. During the financial year in review, we issued 59.5 million additional shares. As at 7 February 2019, the Company has 362.6 million shares in issue (34 million of which came from the capital raise that closed just after the financial year-end) and a market capitalisation of GBP 496.7 million.
Manager’s commentary on top and bottom performers
During the year under review, the Company held 40 companies (the same number as FY2017) and began and ended the year with 27 stocks in the portfolio, although the number in the portfolio peaked at 30 from February to April 2018. We exited 11 positions during the course of the year and made eight new investments. Three of our exits were M&A related (and in two of the three instances, we were reluctant sellers at valuations that we thought were disappointing and at time points that were opportunistic). One of the eight new investments was a re-entry into the portfolio (the biotechnology company Alnylam).
Our top five and bottom five performers in terms of contribution to the evolution of the NAV are summarised below, along with their share price evolution in local currency and sterling over the year (which does not necessarily correspond to their performance for the Company, since the size and duration of our investment may differ, not least because we do trade around our holdings to manage visible risks over time):
|==== Top 5 Performers ====||==== Bottom 5 Performers====|
|Company||Performance (LCY)||Performance (GBP)||Company||Performance (LCY)||Performance (GBP)|
Not surprisingly, the largest positive returns came from our biggest holdings, as one would hope and expect from a concentrated, conviction-orientated strategy. Clearly the outlier in the table above is Celgene, which has been in our top 10 holdings since the inception of the Company and was also in the bottom 5 contributors last year, having fallen 21% in sterling terms. We stuck with the company on the basis that it seemed an impossibly cheap stock on any reasonable medium-term metrics.
In January 2019, Bristol-Myers Squibb took advantage of this fact and proposed to acquire the company in a cash and share transaction. Although we felt that the acquisition price was lower than we had hoped for, we can continue to participate in the upside potential via Bristol-Myers, which remains a significant holding for the Company. It is notable that all of the major detractors are Biotechnology/Speciality Pharmaceuticals stocks, reflecting the broad “risk off” sentiment that has become pervasive in recent weeks.