US-focused Polar Capital Global Healthcare (PCGH), reported interim results this morning, covering the six months to 31 March 2020. The portfolio’s NAV total return over the period was (5.97%), compared to a 0.34% return from the benchmark MSCI ACWI/Healthcare index
PCGH noted that the early part of the period was challenging for fundamental investors, as we grappled with uncertainty over Brexit, a UK General Election and a ramping up of the political rhetoric in the US. During this period, performance was steady and marginally ahead of the benchmark. However, this was all dwarfed in March as fear dominated financial markets, as uncertainty as to the economic impact of covid-19 took hold. Healthcare did well against the overall market, but a sudden dash for cash, liquidity and defensive positioning was very challenging to navigate in those late weeks of the half-year. This caused a marked drag on performance in March, dominating the half-year performance numbers.
Given how the goalposts changed over March, the performance review section of the manager’s report was split into two sections.
The following commentary comes from co-managers, James Douglas and Gareth Powell.
October 2019 to February 2020
“On a geographical basis exposure to the US and Europe was positive with significant outperformance from the US and EU from stock selection. Underweight positioning in Asia Pacific ex Japan was negative as was the gearing which at the end of the period under review was 10.16% having started the period at 7.21%.
In terms of sub-sectors, on allocation, overweight positions in biotechnology and the underweight position in pharmaceuticals were positives, whilst the overweight in medical devices was a negative. Stock selection was positive for pharmaceuticals, healthcare services, healthcare IT, healthcare facilities and healthcare equipment. Stock selection was negative for biotechnology and healthcare supplies.
Positive individual stocks over the period included Horizon Therapeutics, UCB, Dexcom, Cigna and Humana. Horizon Therapeutics outperformed driven by beating sales and earnings expectations, and also showed progress with its drug pipeline. UCB also moved higher due to operational progress and hopes of a turnaround from its drug pipeline. US-based diabetes company, Dexcom, continued to surpass even the most bullish expectations, with its continual glucose monitoring technology the key driver. Cigna and Humana are both leading managed care/healthcare services operators with the former re-rating from a very attractive valuation and the latter continuing to grow strongly given its entrenched position in the fast-growing US Medicare marketplace. Negatives were Quotient, Hill-Rom, Alexion, Beckton Dickinson and Iqvia. Quotient lagged due to a major investor selling their position due to fund closure whilst Hill-Rom underperformed due to uncertainties with the near-term organic revenue growth outlook. Alexion was impacted by concerns over intensifying competition, whilst Beckton Dickinson was hit with a major product issue at the regulator. Lastly, CRO Iqvia missed heightened growth expectations.”
Performance – March 2020
“March was essentially a stock market crash with extreme fear witnessed in the middle of the month. The healthcare sector outperformed, but driven by defensive stocks, including large-cap pharmaceutical and large-cap biotechnology. Also, any companies attempting to develop drugs or diagnostics in relation to COVID-19 saw their stocks outperform. The Company lagged its benchmark by 6.50%, returning -7.13% versus -0.63% for the benchmark.
Asset allocation was a negative driver with the Company being overweight in mid-capitalisation stocks on a relative basis, as was stock selection in large-capitalisation securities. On a geographical basis, overweight positioning in Europe and the US on a relative basis was negative driven mainly by stock selection. On a sub-sector basis, being overweight in biotechnology was a positive in terms of allocation, with negatives being the overweight positions in managed care, healthcare facilities and healthcare equipment. Also, stocks with gearing were punished indiscriminately. The challenge in large-capitalisation stock selection was the impact on healthcare equipment and healthcare facilities sub-sectors. The covid-19 pandemic has led to a collapse in elective care procedures at hospitals, hence the dramatic fall in the share prices of many companies in these sub-sectors. On the drug development side, clinical trials for non-coronavirus drug development have been delayed or paused, negatively impacting the outsourcing providers (Clinical Research Organisations or CROs).
Stocks that outperformed included defensive pharmaceuticals such as Roche Holdings and Novo Nordisk. Other positive contributors included Medley, Centene and Hill-Rom. Medley is a leading provider of telehealth services in Japan and will likely see a significant increase in revenue driven by a dramatic escalation in doctor contact through online forums. Centene, which is primarily focussed on Medicaid and individual exchanges, is the best positioned managed care company considering the likely medium-term implications for rising unemployment in the US. Lastly, Hill-Rom is a medical device company that provides crucial equipment needed at hospitals to treat patients suffering from the virus. The main underperforming stocks included HCA, Smith & Nephew, Quotient, Iqvia and Stryker. HCA is the leading US hospital operator in the US and thus suffered for reasons described above, as did healthcare equipment companies Smith & Nephew and Stryker. Iqvia is the largest CRO and lagged again for reasons described above but also due to its gearing. Quotient, a small-cap stock was weak like other small-caps due to the high beta nature of its stock.”
Strategy and positioning – biotech now the biggest overweight
“Within the growth portfolio, we continue to be underweight pharmaceuticals relative to the benchmark, although do acknowledge that the sector’s defensive characteristics have near-term appeal. With no significant supply-chain issues at the time of writing, pharmaceutical and large-cap biotechnology companies have been largely able to display defensive, operational characteristics through the covid-19 crisis. Patients that require lifesaving medications are getting what they need and indeed, in the very short term, there has been an increase in volumes driven by physicians writing prescriptions for longer periods and enhanced uptake in certain therapeutic categories such an anti-depressants and pneumococcal vaccines. Looking further out however, new drug launches may be temporarily disrupted with sales reps sitting at home instead of interacting with prescribing physicians, and clinical trials could be disrupted if trial sites become inaccessible and/or patient recruitment is challenged.
Biotechnology is now the biggest over-weight in the company, relative to the benchmark. The recent market correction offered a great opportunity to invest in some high-quality companies. With a focus on management teams, differentiated medicines and technologies, we believe the regulatory environment is incredibly supportive at present. Further, the industry is well capitalised and will continue to pursue ground-breaking medical innovation, which should translate into value creation for investors irrespective of the broader macro-economic environment.
We are also over-weight life sciences tools and services, reflecting a view that the challenges facing the end markets are transient. Indeed, not only is the Asia Pacific region starting to show the green shoots of recovery, the industry has been heavily involved in the development and manufacture of testing kits to help manage the covid-19 crisis.
Covid-19 has had a significant impact on the medical device sector as the market digests the dramatic slowdown in elective and non-urgent procedures. As a reminder, hospitals and providers swiftly moved to free-up capacity for COVID-19 patients at the expense of procedures considered to be non-urgent. We remain constructive, however, given there is absolutely no doubt that the demand for medical devices will resume, and the industry will continue to innovate. It is the pace and magnitude of that recovery that is hard to quantify, this uncertainty is reflected in our modest over-weight stance.
The political backdrop has been very supportive for managed care and services companies, plus the near-term sales and earnings trajectories should be reasonably secure given postponed or cancelled elective procedures could ease medical cost trends for the industry. Looking further out, the cost of treating severe COVID-19 patients could be material and rising US unemployment is also a challenge, especially for those with more exposure to the commercial market. Lastly, and this is not healthcare specific, a Biden presidency could bring with it higher corporate taxes, which would have implications for managed care’s medium-term earnings power.
For the innovation portfolio, several assessments have been made due to the impact of covid-19 as many of the companies held are not profitable. All holdings’ balance sheets have been checked for cash runway and the need to refinance. Also, the ability to refinance was considered in the context of volatile stock/debt markets. For companies with products in development, many clinical trials are on hold for obvious reasons. Thus, for all relevant companies, impact to timelines have been analysed and the ability of companies to make changes to trials and maintain integrity of clinical studies in the current environment has been reviewed. This is particularly relevant to Bellus, Zymeworks, Zealand and Quotient. Companies launching new products in particular are facing challenges as sales forces are in lockdown. This is particularly relevant for Biohaven and Axonics. All companies held in the Innovation Portfolio were maintained or increased following the analysis described. Also, a position in ArgenX was added during the weakness in March. ArgenX is a high quality European based biotechnology company which has a large and differentiated pipeline with the potential to generate incredible value over the years to come.
Three companies in particular have products/services that have proven to be important during this crisis. Medley in Japan is a leading provider of software for telemedicine whereby patients can access their doctors through videocalls as opposed to going to the doctor’s practice. Previously utilisation in Japan of telemedicine has been limited. The restrictions on this have been lifted due to the acceleration in infected cases in Japan and should see a significant increase in the use of telemedicine as has been seen in many other countries. Quotient has developed a serological test for research use to assess whether patients have generated antibodies post infection with covid-19. As described earlier, development of this type of system will be crucial in terms of assessing how many patients may have immunity to covid-19, having already been infected. Quotient’s system can carry out 3000 tests per day per machine. Intelligent Ultrasound provided its BodyWorks covid-19 ultrasound simulator at the NHS Nightingale hospital at the Excel Centre in London so clinicians can rapidly be trained to use ultrasound to manage the respiratory impact of the covid-19 infection.
The stocks held in the Innovation portfolio are likely to be more volatile in the weeks and months to come as countries move out of lockdown and likely face further outbreaks of covid-19. Extreme weakness and panic in markets in March created opportunities to add to stocks held in the Company, with Ship Healthcare and Biohaven Pharmaceuticals good examples. As mentioned above, we also added Belgian biotechnology company, Argenx, to the portfolio. Over the short to medium term, new opportunities will likely present themselves to add to these holdings with the potential for upside as all companies held offer significant potential over the long-term which will remain the focus of this part of the company.”
Healthcare outlook is compelling
“The outlook for healthcare is positive given we anticipate the demand for healthcare products and services to continue, and in some cases accelerate, post the COVID-19 crisis. In an uncertain world, the resilient growth profile of the healthcare sector offers appeal, with financially sound large-capitalisation companies especially well positioned. At the same time, the political back drop is supportive, valuations in the US are attractive and we have only just begun to see a change in sector leadership relative to the S&P 500.
The precise pace and magnitude of a post-covid-19 economic recovery is difficult to predict but there is a high degree of conviction that the demand for healthcare products and services is not permanently impaired. Indeed, outside of therapeutics, vaccines and testing kits, other areas of healthcare could see more sustained periods of growth as the system looks to address shortfalls that have, unfortunately, been highlighted by the COVID-19 crisis. The use of telehealth and remote monitoring services, for example, could see broader adoption having undoubtedly proved their value. Manufacturers of ICU units, monitors, ventilators and hospital beds might also see sustained levels of growth as healthcare systems move to insure against future need.
Assessing the opportunity for alternative routes of delivery also needs to be explored given the role that out-patients facilities, ambulatory care centres and home care could play, not just in easing the post-covid-19 backlog, but in offering more efficient and economically attractive platforms for care delivery. Given they address high unmet medical needs, it is hard to envisage a radically different appetite for pharmaceuticals and vaccines in the medium-term. Further, demand for medical devices associated with hitherto postponed elective procedures will likely return, as will investment in the capital equipment and consumables manufactured by the life sciences industry.
In conclusion, whilst we believe that established healthcare companies are well positioned in these uncertain health and economic times, it is also important to note that those that can innovate and produce highly differentiated therapeutics, technologies and services can also flourish. We are fortunate in that healthcare is a very diverse sector, offering opportunities to invest in earlier stage companies looking to disrupt the status quo alongside companies with more “blue chip” characteristics. Financial stability is essential, but we also look for product leadership, a commitment to innovation and experienced management teams with strong track records. Importantly, resilient growth, which we believe healthcare can offer, has high appeal in the current environment.”
PCGH: Interim results from Polar Capital Global Healthcare as biotech emerges as its largest overweight