Economics & Markets
27th June 2024
Dr Michael P. Streatfield, CFA
Quantitative strategist, STANLIB Absolute Returns
Summary
In the middle of a global health care pandemic, with the economy on life support, the health care sector plays a defensive role in portfolio construction. These equities provide a cushion in falling markets, have lower drawdowns, and diversify overall portfolio risk.
However, there are some perceived challenges facing the sector. Despite the coronavirus pandemic, there is only a small margin in global vaccines, and drug pricing could be targeted by the new US administration.
We argue that while there may not be much margin in the vaccine, the pandemic makes governments partners in care, not only in the vaccine rollout but also in tackling future co-morbidities (like the growing global issue of obesity). Incoming US president Joe Biden’s Budget changes will be net positive for health care. Evidence is emerging of long-term health repercussions from the pandemic. To date, there are more than 57 million COVID-19 survivors, but those who have recovered may lead impaired lives.
This creates further economic opportunities for health care, going beyond the supportive longer-term thematic drivers: an ageing developed world consuming more health care; an increased focus on wellness; rising discretionary surgery; medical innovation; and biotechnology breakthroughs.
We believe health care assets should be monitored as we move into a cyclical recovery. As the world normalises, the sector’s pricing power can help to counter expectations of rising inflation.
Defensive nature
We believe global health care should be examined from a portfolio risk perspective, as equity market valuations remain elevated.
Health care is seen as a defensive asset. People will always get ill and spend on their health even in difficult economic times. Innovations are financially promising, but basically health care depends on the cash cow of past drug patents and discoveries.
This leads to more resilient asset class behaviour, less exposed to market downturns. Calculating the bull/bear capture quantifies this defensiveness (See Figure 1). In bear markets, health care (as measured by the MSCI ACWI Health Care sector’s net returns) fell on average -8.1% on an annualised basis, versus the general global equity markets -14%. Health care only took 58% of the losses in the down months.
In the bull market months, health care lagged global markets due to its lower risk nature, but it captured 70% of the upside (13.7% annualised for Global Equity and 9.6% for Health Care). This may look like health care underperformed, but in fact it outperformed the ACWI over this period (7.8% versus benchmark 7.2%). This is the advantage of a defensive asset – it compounds a lower quantum of losses in down months.
Figure 1: Bull Bear Capture: Health Care sector vs Global Equity
We see health care’s defensiveness in the tails when we look at the worst-possible losses in Figure 2: Return Drawdowns of Health Care Sector vs Global Equity, and Table 1. The drawdowns in the global health care sector were not as severe as the entire global equity market. Recovery from these drawdowns was also faster in health care.
Figure 2: Return Drawdowns of Health Care Sector vs Global Equity
Table 1: Biggest Drawdowns for Health Care and Global Equity (ACWI)
The risk statistics over the same period as the chart show health care is still an equity asset, with an annualised standard deviation of 12.6%. This is fairly volatile, but it is two-thirds of the variance of the global equity MSCI ACWI. Health care tails are also not as fat as the broader market (kurtosis of 0.68 versus market’s 2.05) and are not as negatively skewed (-0.38 versus market’s -0.71). This translates to less extreme negative returns, and once again confirms the defensive nature of health care.
Risk protection
A strategic allocation to health care not only provides a more defensive asset, but also attractive overall portfolio risk benefits.
Based on the Bloomberg Global Risk Model, this impact can be assessed by using a proxy for the MSCI ACWI index (the iShares MSCI ACWI ETF), at the end of November 2020. Two of the bottom 10 risk bets are health care factors (US PharmBio and EU Pharm Bio) and these are detracting from overall portfolio risk. Together they have a negative -1.5% marginal contribution to risk. That means adding more assets with this factor exposure will lower overall portfolio risk. Health care has attractive overall portfolio risk benefits in a global equity portfolio.
We now return to the outlook for health care.
Life after the pandemic
It would be short-sighted to assume that health care will not “profit” from the pandemic because the price of the vaccines will be tightly controlled and margins will be low. The pandemic and resulting health challenges create long-term opportunities for this sector.
Apart from age, co-morbidities played a key role in COVID-19 deaths. I will just focus on one of these risk factors as an example. Obesity is the fifth leading risk factor for premature death and it was undoubtedly one of the co-morbidities that increased illness and mortality in this crisis. As the rising slopes show in Figure 3, obesity has moved beyond rich countries to become a global problem, affecting all geographies and income levels.
Figure 3: Regional share of adults that are obese
Obesity is defined as having a body-mass index (BMI) equal to or greater than 30.
BMI is a person’s weight in kilograms divided by his or her height in metres squared. Date from 1975 to 2016
Africa has the second- lowest proportion of obese adults (with 10.6% in 2016), but this is not uniform across the continent. SA unfortunately faces very high levels (28.3% in 2016) and is closer to the worst global region, namely the Americas. Once governments have tackled the short-term challenge of the pandemic, and navigated the vaccine rollout, they have an opportunity to better manage these co-morbidities. The incentive is not only social wellness, but financial, as it promises to lower future public health costs.
Health care companies would welcome public, rather than private health interventions. Health insurers are likely either to ignore obesity as a “lifestyle” issue, or prefer individuals to take surgical options. Governments driving drug interventions, and footing this bill, will be a boon for pharmaceutical companies. Obesity management is good for pharmaceutical and health care companies as it provides potential substantial (and growing – like the population’s waistbands!) future income streams.
Threats to future health
While discussing “fat” in the system, the COVID-19 pandemic also exposed the weaknesses of over-optimised public health systems like the NHS in the UK. In the UK, the number of beds was focused on ongoing care needs, but it lacked sufficient capacity for a healthcare crisis. Despite the older UK population, WHO reports the UK only has 24.6 beds per 10 000 people, equivalent to SA’s 23, but way behind France’s 59.1 or Germany’s 80 beds per 10 000 people. Health care needs will be reassessed politically after the crisis, and it is likely that the public will want to see greater spending on health care.
There is growing evidence that this virus has a lingering effect and is impairing lives. It appears long-term lung damage can occur. Viruses also tend to weaken the immune system. So, this damage could go beyond the lungs, including severe fatigue, joint pain, neurological damage, and heart disease (occurring due to an over-reactive immune system). A number of research programmes are being started to track recovering patients to assess this damage, for example, the UK PHOSP-COVID Post Hospitalisation study.
Although we are unsure of the exact extent of this long-term harm, we can be certain the COVID-19 health care impact will not simply end after a vaccine rollout.
One hand giveth, the other taketh away
Another spectre lingering over health care’s future has been tackling high pharmaceutical prices in the US. Certainly, Medicare’s inability to negotiate drug prices, and consumers’ inability to import drugs for themselves, presented substantial protective, and possibly non-competitive, barriers. However, the Biden Health Care plan is net positive. It will increase spending by $352 billion over ten years (as shown in Figure 4).
Figure 4: Planned Spending Priorities by Biden Administration
Movements by governments both in SA and globally to tighten health care regulation will cause some disruptions. However, moves on drug pricing have been well flagged and companies have had time to adapt. Large capitalisation companies also have the cash and lobbying muscle to engage and shape regulation, and soften any potential blows. I believe that the pandemic makes the health care industry more of a partner with government in jointly solving the health crisis, and relieves governments of some of the blame (perhaps shifting that blame onto technology).
Go for a cycle
This is not a purchase recommendation for health care, but more a discussion of the risk factors and the strategic drivers as we assess health care’s role. In STANLIB Absolute Return Strategies, we look at multiple lenses when making portfolio changes. Momentum is constructive (global health care companies have been raising guidance and price momentum has positive buy signals), valuation is supportive, low volatility is attractive, and sentiment is not excessive (positioning and ETF flows have been modest). Markets continue to have abundant liquidity. Some of the economic opportunities were discussed earlier.
Current positioning in the cycle could be attractive for health care stocks. If a cyclical recovery is indeed under way, with rising inflation risks (though we still expect deflationary forces in the short term), then health care’s pricing power can be a boon in a rising inflation environment. As we monitor the economic recovery and market action, health care is an asset under consideration.
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