For investors the future is bright, but it isn’t pharma
The oft quoted Chinese curse of being “forced to live in interesting times” seems never more apposite for investors, as they grapple with ever-shifting geopolitics, an uncertain economic outlook and historically high asset valuations. Moreover, it does not feel that we have the conventional political tools at hand to soften the blow of any economic slowdown, raising the prospect that a market correction could be both long and painful.
Are at such time death and taxes really the only two certainties for the morose to rely upon? Alas, the Inland Revenue is not quoted on the stock market and Funeral Services companies like Dignity have not proven a safe haven in recent months.
However, there is a third option – illness. It is unavoidable and, with ever more people, who on average are growing older, utilisation will inevitably rise. Caring for the infirm is probably the most certain business proposition one could imagine; demand is quite literally limitless.
Likewise, human ingenuity often feels boundless too. This is surely nowhere truer than in the field of medicine, where we scarcely marvel anymore at the emergence of yet another avenue to ease the burden of human suffering. There is so much more to come; only four percent of identified diseases are defined as curable today. The pace of progress remains dizzying and one can only wonder at what might be routine ten or 20 years hence.
‘Ingenuity’ bedevils the investment industry too, with what could generously be described as mixed results for the real economy and society’s prosperity. On the plus side, today’s investor has all manner of specialist products (both actively managed and cheaper passive ETFs) that can allow one to focus not just on healthcare in the wider sense, but on the various industry sub-sectors and geographies therein (the widely used GICS classification system divides healthcare into ten subgroups; at our fund we use 16). Where then might the best long-term healthcare returns be found?
The rosy bullishness of the healthcare demographic tailwind is only tempered by grim economic reality. Society lacks both the money and the will to pay for the inexorable expansion of our current healthcare system to meet future demand through higher levels of taxation or increasing out of pocket contributions to care. Nor is this a UK problem; the same applies across the OECD. The future then is not just about better treatments, but also reinventing the very concept of how we deliver care and manage people’s wellness over their lives to make it affordable.
Recognition of this realpolitik and increasing openness to new care models is enabling a genuine revolution in healthcare and this is something that investors can participate in, even if some of the opportunities are a world away from curing diseases. In the turgid world of healthcare economics, simple things that affect large populations are of much greater value to society than expensive interventions for rare but serious diseases.
We will summarise a couple of examples of such innovations revolutionising the delivery of care. Perhaps controversially for a publication so named as this, we are not mentioning pharmaceutical or biotechnology companies. Maybe we should first explain why.
Too little, too late
It is not that we have no faith in drugs, nor that we don’t see the innovation opportunity; indeed, we own a lot of biotech. It is rather that we have a fundamental structural issue with the traditional large cap pharma business model as regards R&D productivity, which is both below any reasonable estimate of the cost of capital for such firms and declining rather than rising.
The drug industry has been at the vanguard of the healthcare revolution that has powered improved life expectancy over the past 70-odd years, but that does not automatically make it a good future investment. You could go out and buy a share of UK pharma bellwether GSK for around £13 today. You could have done the same in 2015, 2011, 2007, 2005 or even 2002. In 2000, GSK had a market value of £175 billion, versus £89 billion today.
Biotech, be it the smaller innovators or the (now) old lags like Celgene, Amgen and Biogen, is a superior business model because biologics do not face patent cliffs and have a different development path that makes the (highly expensive) failure risk between phase II and phase III less likely. As such, wastage of R&D capital (which is what depresses pharma returns) is much lower. For example, Amgen’s market cap has risen from £44 billion to £93 billion over the same period.
This alone is enough to explain why the pharma industry increasingly favours biotech-like specialty products versus the old blockbuster model. For most though, this transformation is too little, too late, as the value of incumbency has been dramatically eroded: one only need look how today it is possible to take a biotech product from clinic to market without a big pharma partner in the US.
How about some different types of innovation?
Diabetes is well appreciated as one of the main cost drivers in healthcare and the likes of Novo, Lilly and Sanofi have done well in recent years flogging ever better insulins (at ever higher launch prices). The clinical data suggests that the marginal utility of these products is small; indeed I would go so far as to suggest they are not worth paying for. And yet we cannot ignore that diabetes remains poorly controlled with attended chronic complications and the treatment costs around episodes of hypoglycaemia are considerable (not to mention scary and unpleasant for the patient).
Technology can help though; real-time glucose monitoring and connected apps such as that offered by DexCom allow patients to more precisely regulate insulin dosing, adjust for diet and exercise and warn of impending hypos. When combined with a pump or smart pen, this allows superior control with bog-standard insulin, delivering improved patient satisfaction and lower costs.
In order for a patient to receive a drug, they must first see a doctor. As we all know, this is no longer as easy as it sounds. GP numbers are falling here and in the US, as demand rises and complex chronic needs are placing a higher burden on disease management. When people cannot see a doctor, they vote with their feet and go to hospital, wasting valuable resources. How can we improve GP productivity and better allocate healthcare resources? Again, the now ubiquitous smartphone comes to our rescue. Companies like Teladoc offer highly convenient, low-cost online solutions to accessing care, with costs around 3-4x lower than traditional GP visits. 24/7/365 availability reflects the reality of illness and allows GP (who are increasingly part-time) to work flexibly.
One could be pessimistic about the state of healthcare provision and, in turn, fretting about price control as the only way to manage costs. In reality branded drugs are a small fraction of healthcare costs and cost inflation and society needs to think bigger if it is to deliver the system all will desire at a reasonable cost. Fortunately, this too is an opportunity for investors and we are very bullish both for the future delivery of quality care and for financial return. Change is coming and we should all embrace it.
Paul Major is a portfolio manager at Bellevue Asset Management, which manages the BB Healthcare Trust