Finding the right strategies in the face of a possible economic slowdown can be very difficult. In this sense, one possibility is to focus on the healthcare sector. An area that shows its potential during the pandemic period can only act as a defensive shield for portfolios in the face of rising rates and a potential economic crisis. Andy Ackermanager’s portfolio manager Janus Henderson InvestorsResponsible for the ‘life sciences’ field since 2007 and for biotechnology strategy since its launch in 2018, he explains the industry offerings.
Do you think it is more time than ever to think long-term in the investment process in the future investment strategy? What is your opinion?
At the beginning of this year, we saw that we are facing the highest inflation in the last 40 years. We note that central banks, the Federal Reserve, are behind schedule in raising interest rates. And so we come to this exercise: we become quite cautious and more defensive in our healthcare strategy than we normally would. Therefore, I believe it is necessary to be extremely discreet. When we see inflation above 5% for the last three times since World War II, we finally experience a recession. When you start raising interest rates aggressively, we often face a crisis. Therefore, we entered this year with the feeling that we will experience a serious economic slowdown globally and that as healthcare investors, we have a high probability of ending this recession.
And the fact that it is a sector that can be seen as a defense…
We actually think healthcare is one of the best places to be in a slowing economy worldwide because these companies tend to be pretty defensive. And so we’ve become more defensive than usual in our portfolio, increasing our exposure to stocks we think we can protect. These will be companies that generate a lot of free cash flow. Companies that have lower earnings multipliers, need to be relatively resilient to inflation, and will be minimally impacted by a slowing economy. This will include major pharmaceuticals or major healthcare companies, health insurers. So these are businesses that generate tremendous free cash flow and also have very high margins. Therefore, they have the space to cut costs if necessary due to an inflationary environment.
Are these businesses suitable in an environment of rising interest rates?
With a rising interest rate environment, we believe you need companies that generate income and profits and free cash flow in the short term, not later. So, to answer your question, yes. Therefore, we believe it substantially shortens the duration of the portfolio. We want companies that can provide revenue, profit and cash flow in the short term rather than the long term.
One thing I think is really evident in the healthcare industry is that when there is an economic downturn, corporate profits tend to hold up much more. Generally, they only drop half as much as the rest of the market. Therefore, we remain cautious about the market and economic outlook, but we think this region is a good place to be at a time like this. The last five times the market has fallen by at least 15%, stocks in this industry have fallen only half that of the rest of the market.
So you think the healthcare industry is some kind of defense industry to be in a recession scenario?
Yes definitely. We think that the health sector is a very good place in times of economic hardship due to its defensive nature.
Since your fund is also focusing on the potential of the biotech sector, what potential does this segment offer? Do you think the values are sufficient?
We have been investing in biotechnology stocks for 23 years as part of our global “life sciences” strategy. Historically, we’ve been overweight in this industry as well. The reason we go with the extra pounds is where so many innovations in the industry come from in terms of new drugs. Today, nearly two-thirds of new drugs on the market are developed by small and medium-sized biotech companies. 65% of new drugs are developed by small and medium-sized companies in this industry. It’s a very evolving industry. If we remember when the Covid pandemic hit, at that time most vaccines took ten years to develop and the fastest one took four years to develop. The industry was able to produce two highly effective vaccines in about ten months instead of ten years. And because of this, we think the industry has potentially saved millions of lives around the world. To give you an idea of the momentum of innovation, there have been 256 new drugs approved by the US FDA in the last five years alone. This is 100% more than where we were just ten years ago.
Of course, the pandemic has made us see the importance of investing in science. Do you think this trend will continue?
I think what happened was that a lot of investors got excited about biotech companies and stocks without really understanding the industry. This is a very risky and error-prone industry. That’s why our framework for how we invest in the industry, we call it the 9090 rule, and it refers to the clinical risk of developing a new treatment and the fact that 90% of drugs that begin human clinical trials never reach the market. And so there is a 90% failure rate. So it’s an industry where you really need a lot of scientific expertise to understand which products have the best chance of making it. In May of this year, there were more than 200 companies on their balance sheets that were trading below cash levels. Some even traded for less than half of their boxes.
As a final question: What is the main risk of investing in this type of trend we are discussing?
Investing in biotech companies carries significant risks. We talked about the 9090 rule, the fact that 90% of drugs under development never hit the market. And even when they do, some are business failures. Therefore, investing in this sector is quite risky. And I wouldn’t recommend it to people who haven’t worked for a long time on how to invest in this industry. We always say “don’t try this at home because investing in individual biotech companies is very, very risky”.
It is better to leave it in the hands of experts. This is an area where we believe in an active management approach with a group of investors who truly understand the science as well as the business. Based on our track record of success, we’ve led the global Life Sciences strategy for 23 years. This strategy has outstripped the S&P 500, which has been the market since its launch, by nearly 400 basis points per year, and also outpaced the health index. Thus, it is an area where active management can truly add value to investors.
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