Investing in healthcare – Feature


Yields have held up to a greater extent than they would have in traditional lending markets. Rohit Kapur, Centrica


invest management and a willingness to venture beyond con- ventional asset classes.


This begins with healthcare stocks. A passive investor in some major developed market indices would have had limited expo- sure to the sector last year. Due to the dominance of tech firms, healthcare accounts for only 13.7% of the S&P500 despite their earning power outpacing the broader market during the past five and 10 years. Over the latter, the S&P Healthcare index gained 13.4%, compared to 11.3% for the broader index. But most UK schemes that have sought strategic exposure to healthcare have done so through other asset classes.


Defensive returns One institutional investor with exposure to healthcare is Cen- trica’s UK pension fund. Four years ago, its trustees decided to invest in the sector through its private credit strategy. “It is a lending strategy to North American healthcare compa- nies,” Rohit Kapur, pensions investment research manager at Centrica, says. “It is senior debt and the underlying sectors are pharmaceuticals/biotechnology, medical devices, tools and diagnostics and healthcare services, so the four strands within healthcare, giving us additional diversification. “We have added to it over time because it has performed quite well and we like the defensive characteristics of the industry,” he adds. “Yields have held up to a greater extent than they would have in traditional lending markets.” Accessing healthcare through private credit offers Centrica a competitive advantage, Kapur says. “These tend to be quite complex companies, so I think that traditional lenders, such as banks, sometimes struggle to fully understand their business models, which means there is less competition in this part of the market.” Nevertheless, the strategy looks to mitigate some of the invest- ment risk by only investing in commercial-stage companies with approved products on the market.


Royalties – Steady drip For those wanting development exposure but to cut risk, a pop- ular approach has been to invest in the royalties for the devel- opment of medicines, which offers relatively mature schemes a stable income stream. Examples include the local authority pension schemes of East Riding and Strathclyde, who invested with Healthcare Royalty Partners some five years ago on the basis that investments offered a relatively


high-illiquidity


premium. Railpen also has medical royalties in its portfolio. As of 2019, the pension scheme for rail workers had some £107m invested in medicinal drugs aimed at helping patients with nerve prob- lems manage their pain. According to the scheme, a key advan- tage of this approach is that returns are not just uncorrelated to the performance of traditional assets, but returns are fixed to the lifetime of the drug, rather than being dependent on an exit event or sale.


High risk, high reward


There are voices calling for shareholders to pressure compa- nies into making cheaper drugs to help poorer countries access them. By investing in medicines pension schemes could play a role here, yet there is an inherent tension with their fiduciary duty to offer stable returns. Drug development is very risky. Investors could wait a decade before a medicine earns its first $1 of revenue. Ultimately, it is up to shareholders if they want to pressure their managers into making cheaper pharmaceuti- cals, but it will adjust the risk-reward profile in favour of risk. At look at the market’s reaction to Hillary Clinton’s tweet on drug pricing in 2015 shows what investors think about even a hint that prices could be capped. Around $15bn (£10.9bn) was wiped off the value of US drug stocks the day after she described the price hike of a particular drug as ‘outrageous’ and would lay out a plan to “take it on”.


If companies do lose the power to set their own prices, one thing that politicians cannot change will be the fundamentals. For Kapur, a key benefit of investing in healthcare is the lack of cyclicality and inelastic product demand, which has been dem- onstrated throughout the past year.


“If you invest, for example, in a pharmaceutical company, there will be ongoing demand for their products. It does not drop away just because we are in the middle of a pandemic. “We haven’t seen Covid affecting the underlying revenues of the majority of healthcare companies we are exposed to,” he says. There will always be a need for healthcare. It is hard to imagine that despite breakthroughs in medical science that there will be a time when we are all ailment free.


It is said that death and taxes are the only certainties in life. Perhaps this should be adapted to “death, taxes and periods of ill health”.


Issue 99 | December–January 2021 | portfolio institutional | 57


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