Using Health-Care Stocks For Defensive Positioning

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management. A podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Michal Marszal. I’m a portfolio manager focusing on the global healthcare sector at CIBC Asset Management.

From a perspective of the macro-economic impact on healthcare, it is important to remind investors that as a sector, healthcare is rather macro-economically defensive. The vast majority of the sector is represented by pharmaceuticals as well as healthcare services, which typically have a fairly steady demand profile through the macro-economic cycles. However, there are pockets of the global healthcare sector, accounting for about 15% of the total sector, that will have some degree of sensitivity toward macro-economic downturns. And these are typically pockets of medical devices, elective procedures, et cetera.

So, looking today at the changes that have been taking place within the global economy, I think that the most notable developments are from a perspective of overall growth, as well as inflationary trends.

I think, notably, the North American region has been reasonably resilient. We have seen some pockets of weakness in Europe. And of course, the relatively slow recovery of the China region, from a perspective of overall economic growth, has had an impact on the global healthcare sector, specifically looking at the demand for the discretionary procedures. Here, that was somewhat offset throughout 2023 by the backlog of cases that were worked through post-Covid. So a relatively muted type of an impact. And particularly in Europe, the weakness is then largely offset by the public funded nature of the majority of these types of sub-sectors.

From an inflationary perspective, I think that there are two elements here. We obviously have seen inflation subside, and that’s with respect to the demand side as a reflection of the fact that the demand has been weakened through the interest rate hikes. So that in and of itself mostly had an impact from a perspective of tightening credit conditions. And here, the greatest impact is, as usual, noted in the longest duration assets. So the small and mid-capitalization types of companies, especially in sectors such as biotechnology, have seen credits tightening. That has had some flow through impact on the sub-sectors that are somewhat tied to the financing within these types of various … here, I’m looking at things such as life science and research tools, sub-sector within healthcare. And there has been a notable slowdown.

On the flip side, the positive is the opening up of the supply chains. So again, supply chain constraints have also contributed to inflationary pressures in the past, and these have largely subsided. And that is positive for particularly the broader healthcare technology sector, which is responsible for manufacturing various devices, as well as research tools. And here, that acts as a positive impact on the overall cost of goods. So that is, I think, the totality of what we have witnessed this year with respect to macro economic conditions affecting the global healthcare sector.

Research and development is really at the heart of the global healthcare industry, which has really driven a majority of the value added through innovation. I think that the major pockets of healthcare that are really driven by these types of trends are the global biopharmaceutical sector, where large multinational pharmaceutical companies are heavily investing in research and development activities, continuously trying to advance pipelines of attractive assets. And we have obviously seen over the last decade or so, a tremendous growth within the biotech space. That also provides an inorganic source of innovation for the global biopharmaceutical industry.

And I think looking at the trends here, what we’re seeing is really a steady cadence of innovation, fairly solid progression of pipeline assets across a number of important therapeutic categories. We have seen notable developments in the area of oncology with very advanced treatments. Also, recently, a significant step-up in investments in the area of neurology. And interestingly enough, also a tremendous amount of work now being done in areas such as cell senescence, or aging, with some interesting early developments.

I would also note that the industry is increasingly tapping into the potential of artificial intelligence, augmenting those research and development processes. And that possibly could lead to the speeding up of a lot of the early stage R&D activities, as well as possibly going into the early stage, very early stage discovery phase. And so we possibly could be seeing over the next couple of years, a significant improvement in the overall productivity of research and development in that space, and that really having the greatest amount of impact on outcomes as we look at modern medicine.

Somewhat more of a modest change in terms of the impact of R&D on new product introductions and platform introductions, is what we’re seeing happening in their space of medical devices as well as research tools. The second sector, the research tool sector, being significantly tied to the type of innovation that we’re seeing within biopharmaceuticals, because these are effectively devices that are being used specifically for research in this space. And in these types of sub-sectors, innovation level is more steady, it’s more modest. It’s less revolutionary, more evolutionary. And I think that what we have seen more recently is really a continuation of the trends.

And I would also note that the significant component of the healthcare services space, such as contract research organizations as well as contract manufacturing, also play a very critical role in how research and development is progressing going forward. And these are fairly attractive growth opportunities from an investment perspective because they effectively represent an exposure to the types of trends that I have just highlighted.

Right now, the top picks, as I would probably split them by sector within the global biopharmaceutical industry, some top quality names such as Roche or Novartis would really be top of mind. These companies have very well diversified, high quality-based businesses with underappreciated pipeline assets. And have historically been, really in the top tier in terms of their ability to innovate and advance their pipeline products much more rapidly and with much greater success than their peers.

Within the broader healthcare technology space, I would highlight companies such as Medtronic or Thermo Fisher as again, really well diversified players. Very solid based businesses tapping into durable growth end markets, with a steady cadence of innovative pipeline assets. And within healthcare services within the United States managed care space … which this year has been somewhat less attractive from an investment perspective simply because of the temporary issues with respect to the elevated cost trends. Somewhat of that is tied to what I have mentioned with respect to the backlog of cases that had to be processed this year post-Covid. However, within that, a company like CVS, for instance, represents a very attractive investment opportunity because of its idiosyncratic nature of value drivers.

And within the space of outsourcing of certain services, at topic would be companies such as IQVIA. Again, tapping into some of those really attractive growth trends within research and development. This is a provider of research and development services, so really being at the heart of the innovation engine for the industry. And interestingly enough, being one of the early leaders in adopting artificial intelligence tools to augment those research and development capabilities. And that really being the category leader in that space. These right now would represent really the top ideas within [inaudible 00:08:59] that I think are a really strong setup heading into next year and beyond.

The major risks with healthcare will always pertain to regulatory developments. Investors should always be paying attention to any significant changes within the key healthcare systems in the United States, in Europe, Japan, and China. Some of that pertains to pricing. Some of that will pertain to changes in broader reimbursement, et cetera.

I think right now, given where we are with various election cycles, there may be a significant step-up in the dialogue around possible changes in healthcare cost savings associated with various changes to how healthcare is being ran in various jurisdictions. However, I do not foresee any significant actual developments that will materially change the growth outlook for the entire space.

So while it is important to pay attention to and clearly track any developments that may deviate from this status quo assumption, broadly speaking, we should not be looking at significant types of developments that represent downsides to the space.