Covid has highlighted the importance of healthcare, but for investors are the rewards worth the risks?
Comirnaty is not a typical name for a hero. The one who arrives in times of trouble to save the world. But that is exactly what it might do, and there are a group of investors somewhere who are celebrating. Few people outside of China had heard of Covid-19 at the start of 2020, but the virus soon ravaged the world, killing almost 2 million people by the end of the year and decimating economies as governments told their citizens to stay at home. Then, towards the end of the year, US drug giant Pfizer and German biotech BioNTech secured regulatory approval for a vaccine – Comirnaty – and world leaders lodged orders collectively worth tens of billions of dollars.
There are many similar stories. Pfizer has earned billions of dollars since anti-impotency drug Viagra hit the market in 1998, while another US drug-maker, Gilead Sciences, has made a healthy profit from selling hepatitis C treatment Sovaldi. A course initially cost up to $100,000 (£75,000) and was the first such treatment to be approved in the US, where there are around 3 million suffers.
When Covid-19 hit, private investors, hoping for exposure to the medical world’s next big thing, joined governments and foundations to collectively invest almost $40bn (£30bn) by August to find a cure, says Devex, a media platform for drug developers. This is on top of the $50bn (£36.5bn) that pension funds and other institutional investors around the world invest in biomedical equity each year, according to Slavek Roller of Goethe University Frankfurt.
But investors who have no experience of drug development should not be tempted to rush into the market before considering the huge risks involved. For every one of Pfizer’s successes there are many investors counting their loses from developers’ whose drugs failed in clinical trials, meaning that despite years of pumping cash into those businesses they never earned a single dollar from their research.
Drugs are usually tested in labs before being given to volunteers. Even if it passes that stage of the trials, which assesses safety, efficacy is only tested in the second phase. The third and final stage mass tests sufferers and is usually make or break for the developer in proving that it works. Even if a drug is approved there is the risk that governments or insurers will refuse to pay what the inventor believes it is worth, so drug development may not be a good fit for mature final salary schemes.
It is for good reason that it takes years to develop and test new medicines. Producing a chemical reaction in people is dangerous. No one wants to be responsible for the next Thalidomide, the morning sickness treatment that caused limb deformities in babies in the late 1950s. If this is true, then why, I hear you ask, did Comirnaty and the other five vaccines that have since been approved around the world reach the market within a year?
These are the exceptions, not the rule. They were fast-tracked as the virus was causing enormous disruption and pushing healthcare services to their limit. A similar process is available for rare medical conditions, where lower costs and longer periods of exclusivity are offered to tempt investors to develop treatments known as orphan drugs.
The hunt for a Covid vaccine was boosted by researchers fundamentally changing the way they developed virus samples. This relied heavily on Chinese scientists. They were the first to identify the genetic sequence of Covid-19 as early as mid-January 2020 and made it widely available. This speeded up the development process by enabling scientists to use existing genetic material in their research rather than creating the virus from scratch in a lab.
The Covid crisis has shown how important healthcare is and for investors the underlying trends driving the market are attractive. They include aging populations with one in seven Brits forecast to be over the age of 75 in the next 20 years. Changing lifestyles and increased income levels across emerging markets are also factors as is innovation. The collaboration that saw the rapid development of the Covid-19 vaccines is an example of increasing efficiency in drug development. Chronic lifestyle-related illnesses are rising, such as diabetes. The cost to the NHS and other health services is growing with the number of sufferers of these uncurable conditions expected to reach 642 million by 2040, a rise of 54% in 25 years. Indeed, King’s College forecasts that the cost of managing the condition will almost double to $2.5bn (£1.8bn) by 2030.
But there are ways to gain exposure to these trends for less risk. Investors could back the commercial-phase giants of the industry which have several drugs on sale and many more in development, such as GlaxoSmithKline, Sanofi, Johnson & Johnson, Roche, Novartis, Merck and Pfizer. If any of their drugs fail to reach the market, it will mean money wasted but will not take a large chunk out of their value. Indeed, AstraZeneca’s share price fell only 1.5% after announcing disappointing results from third phase trials of an asthma drug in December, while US small cap Neurotrope lost 80% of its value 18 months ago when tests proved its Alzheimer’s drug did not work.
Pharmaceutical and biotech developers are not the only players in the market. Healthcare also includes medical technology, private hospitals, care home operators for the elderly and disabled as well as owning clinics and GP surgeries. The range of options is equally broad in terms of asset classes, from plain vanilla investments in equity, private debt or the rights to future earnings.
But what all aspects of this sector have in common is that investments tend to predispose active invest management and a willingness to venture beyond conventional asset classes. This begins with healthcare stocks. A passive investor in some major developed market indices would have had limited exposure to the sector last year.
Due to the dominance of tech firms, healthcare accounts for only 13.7% of the S&P500 despite their earning power outpacing the broader market during the past five and 10 years. Over the latter, the S&P Healthcare index gained 13.4%, compared to 11.3% for the broader index. But most UK schemes that have sought strategic exposure to healthcare have done so through other asset classes.
One institutional investor with exposure to healthcare is Centrica’s UK pension fund. Four years ago, its trustees decided to invest in the sector through its private credit strategy. “It is a lending strategy to North American healthcare companies,” Rohit Kapur, pensions investment research manager at Centrica, says.
“It is senior debt and the underlying sectors are pharmaceuticals/biotechnology, medical devices, tools and diagnostics and healthcare services, so the four strands within healthcare, giving us additional diversification. “We have added to it over time because it has performed quite well and we like the defensive characteristics of the industry,” he adds.
“Yields have held up to a greater extent than they would have in traditional lending markets.” Accessing healthcare through private credit offers Centrica a competitive advantage, Kapur says. “These tend to be quite complex companies, so I think that traditional lenders, such as banks, sometimes struggle to fully understand their business models, which means there is less competition in this part of the market.” Nevertheless, the strategy looks to mitigate some of the investment risk by only investing in commercial-stage companies with approved products on the market.
Royalties – Steady drip
For those wanting development exposure but to cut risk, a popular approach has been to invest in the royalties for the development of medicines, which offers relatively mature schemes a stable income stream. Examples include the local authority pension schemes of East Riding and Strathclyde, who invested with Healthcare Royalty Partners some five years ago on the basis that investments offered a relatively high-illiquidity premium.
Railpen also has medical royalties in its portfolio. As of 2019, the pension scheme for rail workers had some £107m invested in medicinal drugs aimed at helping patients with nerve problems manage their pain. According to the scheme, a key advantage of this approach is that returns are not just uncorrelated to the performance of traditional assets, but returns are fixed to the lifetime of the drug, rather than being dependent on an exit event or sale.
High risk, high reward
There are voices calling for shareholders to pressure companies into making cheaper drugs to help poorer countries access them. By investing in medicines pension schemes could play a role here, yet there is an inherent tension with their fiduciary duty to offer stable returns. Drug development is very risky. Investors could wait a decade before a medicine earns its first $1 of revenue. Ultimately, it is up to shareholders if they want to pressure their managers into making cheaper pharmaceuticals, but it will adjust the risk-reward profile in favour of risk.
A look at the market’s reaction to Hillary Clinton’s tweet on drug pricing in 2015 shows what investors think about even a hint that prices could be capped. Around $15bn (£10.9bn) was wiped off the value of US drug stocks the day after she described the price hike of a particular drug as ‘outrageous’ and would lay out a plan to “take it on”. If companies do lose the power to set their own prices, one thing that politicians cannot change will be the fundamentals.
For Kapur, a key benefit of investing in healthcare is the lack of cyclicality and inelastic product demand, which has been demonstrated throughout the past year. “If you invest, for example, in a pharmaceutical company, there will be ongoing demand for their products. It does not drop away just because we are in the middle of a pandemic. “We haven’t seen Covid affecting the underlying revenues of the majority of healthcare companies we are exposed to,” he says. There will always be a need for healthcare. It is hard to imagine that despite breakthroughs in medical science that there will be a time when we are all ailment free. It is said that death and taxes are the only certainties in life. Perhaps this should be adapted to “death, taxes and periods of ill health”.