How To Invest In Healthcare: What You Need To Understand

Timo de Groot Feb 2017 - 8 min read

From a long-term investing point of view? The healthcare industry offers a compelling investment thesis. The sector is likely to generate many investment opportunities in the coming years. Because it’s driven by a powerful combination of interlinked structural forces. This article will teach you how to invest in healthcare.

Healthcare – a classic secular growth story

A ‘secular’ trend is a trend that plays out over a long period of time. By identifying secular trends in their infancy? Investors can capitalise on long-term growth stories, generating powerful long-term investment returns.

In healthcare, we have a classic secular growth story. Because there are several forces that should drive the sector forward in coming years. Including demographics, economic development and major health issues.

Here’s a closer look at some of these powerful drivers.

The world’s ageing population

At the core of the healthcare investment thesis lies a dominant trend. One that is impossible to ignore: the world’s ageing population.

Consider these statistics:

  • By 2030 the average global life expectancy will rise to 85, up from 71 in 1970, according to the World Bank.
  • According to the National Institute on Aging? The number of people aged 65 or older is set to grow from 8% of the global population now, to 16% in 2050.
  • In the US alone, 10,000 baby boomers are expected to turn 65 every day until 2030.
  • The over-80 age group is expected to more than triple in size over the next 30 years. Rising to 4.5% of the global population by 2050.

It’s no secret that as people age, their need for healthcare related products and services increases. In the United States, healthcare spending on the elderly is three times that spent on the general working-age population.

The healthcare industry will benefit from the growing number of elderly. According to projections from the World Bank? Spending on healthcare is expected to rise from 7.1% of global GDP in 2013 to 9% by 2040. More than a 25% increase in the sector’s share of the global economy.

Economic development

Demand for healthcare will not just be limited to the developed world though. There’s a strong correlation between GDP and healthcare spending. As countries such as China, India and Brazil develop, their healthcare demands will increase. Emerging markets are expected to add USD $1 trillion in extra global healthcare spending by 2050.

Lifestyle factors

Modern day lifestyles are another driver of healthcare demand. With a significant increase in sedentary lifestyles? Global obesity rates are on the rise, both in the West and in developing countries.

Diabetes is closely associated with obesity and urbanisation. And it has increased sharply in recent decades. Demand for drugs that combat these health issues is likely to remain robust going forward.

Attractions of investing in healthcare

So we know that the healthcare industry is likely be driven forward by several powerful forces in coming years. But what other factors make the sector appealing from an investment point of view?

Constant demand

One key attraction of investing in healthcare? Demand for healthcare products and services is relatively stable. Irrespective of the global economic cycle. Economies go through boom and bust cycles. But if there’s one constant, it’s that people always get ill. So, there’s a consistent demand for drugs, hospitals and medical devices. No matter the state of the economy.

Healthcare stocks can often fare better than the broader market during market downturns. Because the incidences of cancer, heart disease and diabetes do not decrease as the economy softens.

Undemanding valuations

Despite the long-term fundamentals of the industry, the healthcare sector as a whole looks attractively valued at present. Many healthcare stocks have underperformed relative to the broader equity market in recent years. And as a result, the sector looks appealing on a historical valuation basis. Prominent UK fund manager Neil Woodford has stated that on some measures, the sector has not been as attractively valued as it currently is since the early 1990s.

Concerns regarding the future state of healthcare policy in the US have created an element of short-term uncertainty in recent years. As a result, many investors have approached the sector with caution. Yet, the long-term fundamental drivers are still very much intact. This could attract those willing to look beyond the short-term uncertainty. Because the sector offers appealing growth prospects and rising dividends yields, at undemanding valuations.

Powerful dividends

Furthermore, large pharmaceutical companies can be excellent investments for dividend investors. With several of the larger pharmaceutical companies paying out market-leading dividends yields. Indeed, FTSE 100 healthcare giants GlaxoSmithKline (GSK LN) and AstraZeneca (AZN LN) currently yield around 5%.

Dividends can make a significant contribution to long-term returns. With some studies concluding that dividends contribute up to 80-90% of total investment returns over the long-term. For those looking for income? Or just looking to put the power of compounding to work through the reinvestment of dividends? Healthcare stocks can make excellent core portfolio holdings.

M & A potential

There’s also strong potential for merger and acquisition activity in the sector. To thrive in this industry, companies need to stay innovative. One way for the larger pharmaceutical companies to do this? Acquiring other smaller companies for their pipelines of future drugs. This is a trend we have seen in recent years.

Risks of investing in healthcare

Of course, investing in the healthcare sector is not without risks. Two critical issues that investors need to be aware of include the cost burden of the industry, and the loss of patent protection of key drugs.

Cost pressures

With demand for healthcare increasing as populations age? The cost of this healthcare is a critical issue for governments around the world.

Spiralling healthcare costs are becoming an ever increasing proportion of GDP. And in the United States alone, total healthcare spending is forecast to grow from 16.9% in 2015, to 23% of GDP by 2040. This according to the Organisation for Economic Co-operation and Development (OECD).

As a result, governments are looking to control costs by creating efficiencies. This means that companies that can make their products more efficient, productive or cheaper should thrive. While companies that fail to innovate and make their products available as efficiently as possible may struggle.

Patent expirations

Another key issue affecting pharmaceutical companies is the loss of revenue that can occur when patents on key drugs expire. Over the last few years, patent expirations have led to steep revenue losses for some of the world’s largest pharmaceutical companies.

For example, in 2016, AstraZeneca lost patent protection for two of its major drugs – Crestor and Seroquel XR. Together these drugs accounted for annual revenues of around $7.3 billion, leaving a big hole in the company’s top-line.

It’s a theme that has affected many of the prominent pharmaceutical players in recent years. And with many more key drugs set to lose their patent protection over the next decade? It’s an area that healthcare investors should watch closely.

One consequence of this risk factor? It has the potential to spur consolidation within the sector. Pharmaceutical companies will look to replace blockbuster drugs whose patents expire. The will replace them with drugs that have potential to be key revenue drivers.

How to invest in healthcare

So we’ve covered the attractions and the risks of investing in the healthcare sector. The next step is looking at how to actually invest in the sector.

There are many ways to invest in healthcare. Ranging from diversified healthcare funds, to large-cap dividend paying pharmaceutical giants, to tiny micro-cap biotech firms.

Let’s start with the diversified approach.

Healthcare funds

Mutual funds specialising in the sector could be a wise choice. Especially for beginner investors with a lower risk tolerance. Or for investors seeking a diversified approach to investing in the healthcare sector.

The key benefit of this approach? It reduces company-specific risk, as your capital is spread over a range of companies.

Some of the more popular healthcare specific funds include:

  • The AXA Framlington Health fund, which is predominantly invested in large-cap companies.
  • The Worldwide Healthcare Trust, a diversified portfolio of 60-70 pharmaceutical firms.
  • The Polar Capital Healthcare Opportunities fund and the Polar Capital Global Healthcare Growth and Income Trust.
  • The Woodford Patient Capital Trust, which has a near 70% weighting towards the sector.

The last fund on that list is the Woodford Patient Capital Trust. It’s run by well-renowned UK fund manager Neil Woodford. Woodford is bullish on the healthcare sector. And he has made it clear that he believes the sector should outperform in the long run. The fund manager also has a strong bias towards the healthcare sector in his Woodford Equity Income Fund.

Healthcare ETFs

Exchange traded funds (ETFs) are another way of gaining exposure to the sector. They can offer similar diversification benefits at lower costs than traditional mutual funds.

Two popular healthcare ETFs include:

  • Legal & General’s Global Health & Pharmaceutical Index.
  • db X Trackers MSCI World Health Care TRN Index.

Individual stocks

Europe is home to some of the most well-known healthcare companies in the world. And more experienced investors may prefer to invest in specific companies. Here’s a look at some of the key European players.

Roche (ROG VX)

Swiss-based Roche (ROG VX) is one of the largest pharmaceutical companies in the world. Operating across two main segments – pharmaceuticals and diagnostics. The company has a strong portfolio of traditional drugs. With a particular focus on cancer treatments.

Roche has spent significantly on research and development in recent years. They have been investing heavily to generate future growth. And the company now has a robust pipeline of potential new medicines.

The pharmaceutical giant’s exposure to emerging markets including China, Latin America and the Middle East should help drive revenue growth going forward. Roche believes that up to 50% of future earnings will come from the emerging markets.

Roche looks attractively valued at present, and looks to be a good play on the fight against cancer.

GlaxoSmithKline (GSK LN)

FTSE 100 giant GlaxoSmithKline (GSK LN) is another of the world’s healthcare powerhouses. They focus on research and development in a broad range of innovative products. In the three main areas of pharmaceuticals, vaccines and consumer healthcare.

GSK had an asset swap with Swiss-based Novartis in 2015. Now the company has a higher focus on vaccines and consumer health products. This should result in consistent revenues and cash flows going forward.

The company is trading at a reasonable valuation and sporting a dividend yield of around 5%. So, the company has appeal for those seeking capital growth or income.

Novo Nordisk (NOVO-B CO)

Danish firm Novo Nordisk (NOVO-B CO) is a specialist in diabetes care. Providing nearly 50% of the world’s total insulin products by volume.

Other large pharmaceutical companies have seen revenues plateau in recent years as patents expire. But Novo Nordisk has enjoyed a period of strong growth. With revenues more than doubling over the last six years.

Yet, with over a third of its sales in the US? The company is exposed to potential price curbs from the US administration.

Alternative: Hikma Pharmaceuticals (HIK LN)

For a play on the generic drugs angle? Investors could look at FTSE 100 listed Hikma Pharmaceuticals (HIK LN).

Hikma is a company based in Jordan. It develops and manufactures a broad range of branded and non-branded pharmaceutical products. This across the US, Europe and the MENA region.

Management has a strong record of delivering shareholder value through acquisitions and organic growth. And revenues have grown considerably in recent years.

The company has a portfolio of over 550 healthcare products. And after the recent acquisitions of Bedford Laboratories and Roxane Laboratories? It now has many more products in the pipeline. Earnings are forecast to drop, while the company integrates its recent acquisitions. So, the long-term story looks attractive.

Of course, this is just a look at a handful of well-known healthcare stocks. And there are thousands of other companies listed in Europe that offer exposure to the sector.

Larger companies offer more stability and generally pay solid dividends. But smaller biotech companies can offer more potential for sizeable returns. Yet, there is a high failure rate among the smaller biotech companies. Because they only develop a small number of drugs. So, they are generally more risky.

As with any sector, diversification is important to cut company-specific risk.

Conclusion

In summary, the healthcare sector has many attractions for the long-term investor. These factors are likely to drive the industry forward:

  • Ageing populations
  • Emerging market growth
  • Urban lifestyles

This will ensure that demand remains robust for the foreseeable future.

Mutual funds and ETFs offer diversified exposure to the sector. While more experienced investors may prefer to invest in individual healthcare companies. Both have the potential to provide capital growth and income over the long-term.

This article is for educational purposes only and should not be seen as financial advice.
Investment learning

Learn How to Invest Invest in Healthcare

Try to invest in healthcare yourself and track the performance of your virtual portfolio.

Create Your Free Virtual Portfolio