Practical analysis for investment professionals
13 December 2016

Health Care Investing: The Promise and the Pitfalls

The CFA Institute Equity Research and Valuation Conference is an annual event covering global investing strategies and valuation approaches and analysis. The Equity Research and Valuation 2017 Conference will bring together world-class equity investors in New York, New York, on 14–15 November.

For Andy Acker, CFA, portfolio manager of the Janus Global Life Sciences Fund, these are especially exciting times for investors in the health care sector. Opportunities abound, as significant advances in understanding the genetic causes of disease have resulted in a surge in new and more effective treatments.

At the same time, risks remain and a disciplined approach to stock selection and portfolio construction is imperative for success. A seasoned investor — he’s been with Janus for nearly two decades — Acker recently spoke to delegates at the CFA Institute Equity Research and Valuation 2016 Conference in New York about the promise and pitfalls of investing in health care stocks.

Acker offered a candid review of some of his most successful investments as well as some of the battle scars he’s endured over the past decade, experiences that have helped to shape his current investing approach. And while he is optimistic that therapeutic breakthroughs will continue apace, he also warned that health care stocks typically produced the biggest disparity between winners and losers of any sector of the stock market. According to Acker, however, it is the often binary nature of health care investing — a drug under development either works or it doesn’t — that offers opportunities for talented active managers to generate alpha.

Below are some main points from Acker’s presentation:

The Promise of Health Care Investing

  • Increasing Innovation: The pace of innovation is accelerating, bringing about “revolutionary changes instead of evolutionary changes,” according to Acker. Moore’s Law, which stipulates that the processing power of computers doubles every two years, has been dwarfed by the progress made in sequencing the human genome. The original Human Genome Project (HGP) was completed in 2000 after 13 years of research and at a cost of about $3 billion. Today, a human genome can be sequenced in just one day at a cost of about $1,000. It’s likely no coincidence then that in 2015 the Federal Drug Administration (FDA) approved 45 new drugs, the most in 19 years.
  • Favorable Demographics: Most of the developed world has an aging population: 10,000 US baby boomers are expected to turn 65 every day until 2030. Why is this important? Because in the United States, health care spending on the elderly is three times that spent on the general working-age population.
  • Growing Globalization: Growth in GDP correlates strongly with higher health care spending, and emerging markets like China and India are expected to add $1 trillion in additional global health care spending by 2050, according to Acker.
  • Defensiveness: Health care stocks typically fare better in market downturns for the simple reason that incidences of heart disease, diabetes, and cancer don’t abate as the economy softens. In four of the past five stock market corrections of 10% or more, the health care sector has outperformed the broader market, Acker said.

Health Care Investing Pitfalls

  • Clinical Risk: Historically, only 10% of drugs that enter human clinical trials become commercially viable, and identifying the winners in advance — finding that “needle in a haystack” — is fraught with risk. Acker sees this as an opportunity for skilled active managers, particular those with scientific training.
  • Commercial Risk: Consensus revenue estimates for new drug launches are wrong 90% of the time, according to Acker. To mitigate this risk, he and his team try to understand the perspective of “the three Ps: physicians, patients, and payers.” Knowing whether doctors and patients are enthusiastic about a drug, and understanding whether insurance companies are likely to find it cost effective, improves the accuracy of financial forecasts.
  • Construction Risk: Acker generally avoids significant industry bets and invests about half of his portfolio in “core growth companies,” or firms with dominant market shares and strong and sustainable cash flows. The balance of the portfolio is invested in “emerging growth companies,” firms with a new product that promises to boost financial results, and in “opportunistic investments,” typically special situations involving turnarounds, restructurings, or spin-offs. Using a value-at-risk framework, he seeks to limit downside risk of individual stocks in his portfolio to 100 basis points (bps), based on a worst-case-scenario analysis.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/MHJ


Video



Key Takeaways

  1. A disciplined approach to stock selection and portfolio construction is imperative for success in healthcare investing.
  2. Increasing innovation, favorable demographics, and growing globalization are positive forces for health care investment returns, along with the defensive investment value of health care stocks in market downturns.
  3. Clinical risk, commercial risk, and construction risk are potential pitfalls when investing in health care stocks.

Transcript

THE THREE Cs OF HEALTHCARE INVESTING
ANDY ACKER, CFA

View the full transcript (PDF).


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About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, is director of Member and Corporate Products at CFA Institute and serves as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

2 thoughts on “Health Care Investing: The Promise and the Pitfalls”

  1. richard says:

    My wife is a very smart person and has always insisted on having a chunk of her portfolio in Vanguard Health Care (VGHCX) and it’s done amazingly well for years—even though the science says betting on a single sector is a bad idea.
    If I were as smart as her and had allocated her entire portfolio into it like she wanted to, we’d be living in a penthouse by now.
    But that’s investing for you….

  2. Joanne Ott says:

    Thanks for sharing your healthcare market insights. There is much to gain from the healthcare revolution, yet your key take-away in innovation (HGP) seems to cancel out with clinical/commercial risks! It seems you are looking in the wrong place and it doesn’t have to be a ‘needle in a haystack.’ Remember, it takes 17 years on average for drug innovations to come to market and like you pointed out – 90% of the drug launches are wrong! Why then are we focusing on the ‘needle in a haystack’?

    The biggest innovation in healthcare is integrative medicine and biophysics technology! For one, let me point out Functional Medicine and their work with microbiome! They are in the Cleveland Clinic and have doubled in just one year under operations. There track record is astonishingly better as they treat root cause, not symptoms like drugs do. This is the new story you are missing.

    The human genome project has spent over $5.4B. The result was sequencing ~22,300 gene expressions – a very limited capacity to identify what influences disease and health! Yes, an awesome advancement, yet it is the epigenetic influence of gene replication that really matters (influences DNA replication via the environment) and the microbiome is much more important! (In fact the ‘junk’ DNA they ignored for most of the HGP was later found to be the key.)

    Mapping the microbiome’s funding is a pittance at only $115M. Yet their are 100 trillion bacteria cells that exist in our body and have a direct gut-to-brain influence. It seems $$$ should really be pumped into this innovation. Rather, you get what you invest in – more drugs that produce ‘needle in a haystack’ phenomenon.

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