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Finding growth in a low growth world

Is the investment pendulum swinging from income back towards growth strategies? Polar Capital fund manager Dan Mahony believes it is and focusses on healthcare as one of the ‘few long-term secular growth sectors in a low growth world’

When advising clients, you need to know their end financial and lifestyle goals before you can build a credible financial plan. In asset management, it is also important to know the needs of your customer, which in many cases may be another finance professional.

The low interest rate environment of the last few years means there has been a bias towards asset managers providing income-generating products, you only have to look at some of the most recent high profile launches to see that.

However, a balanced investment strategy that targets long-term financial goals requires a combination of income and growth.  Our recent discussions with clients lead us to believe that the pendulum is beginning to swing back and there is a renewed interest in growth opportunities.

The key question is – where do you look for it?  Well, healthcare continues to be one of the few long-term secular growth sectors in a low growth world that is suffering from persistent deflationary pressures.

Changing demographics, with an ageing population, innovation and the need for greater efficiency create a number of different investment opportunities across the healthcare sector.

The biggest perceived risks for healthcare, that current Government spending is unsustainable and healthcare systems are at breaking point, are actually the biggest catalysts for this change. Major structural transformation occurs when innovative technological change meets economic necessity – the healthcare industry has crossed a Rubicon and this process has already begun.

For the broader economy, an aging population is a massive problem. As life expectancy has increased over the last few decades, coupled with the post-war “baby boom”, the ratio of people aged over 65 to the population aged 15-64 (i.e. of working age) has been rising and will continue to increase over the next decade. This has a significant deflationary impact on GDP for most industrialised economies even before factoring in the effects of current macroeconomic policy and low interest rates.

For healthcare companies, the demographics and an aging population are a major positive driver. People aged over 65 need, and demand, more and better healthcare as they head into retirement. Nevertheless, this demand creates a political problem as governments are struggling to meet these expectations given the limits on government spending.

Governments need to start delivering better healthcare to more people for less money – the whole healthcare industry needs to provide a significant improvement in efficiency to meet the demands of the aging population.

This economic necessity is the catalyst for the beginning of a major structural change in healthcare. The driver of change is the embracement of information technology – particularly faster computer processing power and big data analytics – that on the one hand is enabling the development of new methods to treat disease, such as new drugs or medical devices; and on the other is helping to re-shape the entire system and the way that healthcare is managed and delivered.

The opportunities

From an investment perspective, this means that there are opportunities within healthcare that extend well beyond the large pharmaceutical companies that are household names. Now is the time to look at companies developing medical devices and equipment, hospitals and healthcare services, health insurers and even technology companies developing solutions focused on the healthcare sector.

The most important near-term ramification of this digital-driven disruption of healthcare is the move towards value-based reimbursement. Reimbursement systems across the world are beginning to move away from a “fee for service”, volume-based system to one that rewards quality and improved clinical outcomes.

There is now an emerging focus on evaluating the value delivered by a therapy, whether it is a drug, device or a healthcare service. The price of a drug or device may not just be based on the efficacy data collected in a controlled clinical trial. New digital health technologies are emerging that will enable governments or insurers to evaluate the effectiveness of therapy in the “real world” and so may allow an adjustment in reimbursement and price post-approval.

As a result, focus should be on identifying companies that are developing products or services that can deliver better and/or more cost-effective care. In a cost constrained environment, these companies should be able to deliver sales and earnings growth.

With any major structural change there are risks and opportunities – especially for the incumbents. Large companies need to embrace this digital transformation of healthcare so that they can benefit from the long-term demographic changes and so deliver steady and reliable free cash flow growth.

For example, UnitedHealth, the world’s largest health insurer, has a division called Optum that is leading the way in the analysis of healthcare data. Optum is changing the way the insurer monitors its existing book of business; creating new ways of evaluating and rewarding its healthcare service providers; and also identifying new technologies that help patients to adopt healthier lifestyles.

There is also a new trend for healthcare companies to use consolidation as a route to improving efficiency. Medtronic, the world’s largest medical device company, is an excellent example of this. It has expanded its breadth of business through acquisition so it can provide a broader range of medical products to hospitals, take market share from smaller competitors and ultimately deliver better value to its customers.

Consolidation is also one of the reasons that there is greater pricing pressure in pharmaceuticals. Over the last five years, there has been consolidation within different sub-sectors including health insurance, hospitals/healthcare services and pharmacy benefit managers. Greater purchasing volume shifts the balance of power in pricing discussions.

Looking for management teams that are reformulating business models to adapt to the new environment is critical.

Innovation has been a key part of healthcare investing for many years, especially for small and mid-sized companies. Looking for the innovators that are disrupting healthcare with new drugs, devices or services that improve clinical outcomes and often create new markets with strong pricing power and revenue growth opportunities.

Advances in information technology are having a significant impact on innovation in healthcare and the speed of innovation is accelerating. There are a number of investment opportunities across the biotechnology sector and in smaller medical device companies. These types of companies, which are often developing treatments for unmet medical needs, should be a focus for investors

The emergence of digital health is really exciting, an all-encompassing term that covers a broad array of products and services arising from the convergence of information technology with healthcare. Digital health could make the concept of patient-centric care a reality and give individuals access to cutting-edge medical technology that could help them monitor and prevent disease in the home.

The healthcare sector has embarked upon a period of major structural change that will have a significant impact on all of our lives.  For investors looking for growth, it is a great time to re-visit healthcare as this change is creating exciting opportunities across the sector.

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