Healthcare stocks are at record underweights in US investors’ portfolios but the dispersion among the sector is creating excellent opportunities, according to Worldwide Healthcare Trust’s Sven Borho. 
The manager of the five FE Crown-rated trust said the main reason behind the apathy towards the sector is that investors have been focused solely on the large technology names such as the FAANGs (Facebook, Amazon, Apple, Netflix and Google).
“Everybody is saying ‘I am in tech. I don’t understand what is going on with drug pricing, Donald Trump always tweets, 2015/16 was terrible period, I don’t need to be in healthcare’,” he said.
This dispersion has come through strongly recently, as over the past three years the MSCI World Information Technology index has far outpaced the trust’s MSCI World Healthcare benchmark.
Performance of indices over 3yrs
Source: FE Analytics
He noted that, as such, positioning surveys in the US have shown that investors are at record relative underweights to the healthcare sector.
“It has just turned around a little bit in the month of July on the back of some good second-quarter numbers but there hasn’t been a need to be in healthcare,” Borho said.
He added that the sector has seen net outflows each week for the at least the past year, although in recent weeks this has begun to reverse.
As such, on a relative basis, US healthcare trades at a discount to the wider market, something that has happened rarely over the past 20 years.
Indeed, valuations have eclipsed the discount seen during the period between 2015 and 2016, when investors feared that presidential candidate Hilary Clinton could force through major reforms in the sector if she came into power.
The Worldwide Healthcare Trust manager noted: “You typically only get healthcare at a discount to the market when we are in the midst of major healthcare reforms like in 1993-94, which was Hilary Clinton healthcare reform number one, when we were trading at 20 per cent discount at the peak.
“Or during the Obamacare implementation years when healthcare had been at a meaningful discount as well.”
However, currently there is no major upheaval anticipated in the healthcare system – rather incremental changes – yet it remains on a wide discount.
This has created some wide dispersions within the sector, with large-cap pharma, big biotech and generics largely unloved while newer technologies or potential M&A (mergers and acquisitions) names have fared better.
“When you talk to sell-side analysts they will tell you that nobody wants to talk about big biotech value plays – nobody cares,” Borho said.
“If you looked in the sub-sector it is pretty stunning that there is such a big dispersion of valuations between the most extreme pharma and large biotech names, which are far cheaper than the market, and you have a few sectors that are more expensive.”
The other areas in healthcare that the general investors dabble in is areas where there is no possible drug pricing pressure like the tools and diagnostics space and the MedTech space, he added.
Yet there are reasons for investors to continue to back healthcare, particularly at the moment, with the first being the potential for more M&A deals.
“I think M&A is important and I would have expected more this year. There has been some – especially at the beginning of the year – but you had US tax reform and that enabled the US-based companies to repatriate a lot of their offshore cash,” he said.
US companies, the Worldwide Healthcare Trust manager noted, have been desperate to bring some of that cash back to the US to help fund acquisitions, with a number of good opportunities on the market.
However, since the reforms came through, there has yet to be in the influx of moves he expected when talking to management teams.
Instead, these companies have chosen to use the cash on share buybacks rather than bolt-on acquisitions.
“Some of the big companies have been a bit distracted by what is going on in Washington DC and the uncertainties there coming from the political point of view and have to work with that,” he said.
But he remains confident that investors will begin to see more deals in the pipeline come through by the end of the year.
“Sometimes it is tough to predict it. It could happen tomorrow. I think it is long overdue. I am pretty sure things are in the works for the rest of the year,” Borho said.
The other area of interest is in finding the next big thing within the sector. For example, immune-oncology has been a big area in recent years.
However, with drugs coming through the pipeline to tackle such complex diseases as cancer, people are living longer, other illnesses becoming more attractive to tackle.
“A controversial area is Alzheimer’s disease. I think over the next 12 months we are possibly going to get to a stage where Alzheimer’s disease becomes very interesting for investing purposes,” he said.
“You have late-stage clinical data readouts and I think we could possibly have in late 2019/20 where maybe a disease modifying agent is getting close to the market.”
The rationale behind this is that with people living longer, and fewer dying from heart attacks, infections and other diseases, later-life illnesses such as dementia and Alzheimer’s will become more of an issue.
“In terms of market size and potential is the holy grail in healthcare because the problem is so big and only getting bigger as the population ages and more and more people no longer die of heart attacks and infections,” he said.
“That is an area that is going to heat up over the coming months. There has been a lot of excitement there but not many people have been taking note of it.”
Borho runs the £1.4bn Worldwide Healthcare Trust alongside Trevor Polischuk, who joined him at the end of last year.
It has been a strong performer, returning 512.29 per cent over the last decade, significantly ahead of the MSCI World Healthcare index.
Performance of trust vs sector and benchmark
Source: FE Analytics
The investment company is currently 32.1 per cent invested in biotech names with 31 per cent in pharmaceuticals.
The trust is 8 per cent geared and is on a premium of 1.3 per cent relative to its net asset value, according to data from the Association of Investment Companies (AIC). It has ongoing charges including a performance fee of 1.73 per cent.