The Doctor is In... A Review and Preview for the Healthcare Market

Tekla Capital Management

Investing in healthcare companies continues to be an interesting and dynamic endeavor. As investors, our primary emphasis at Tekla has been to identify novel technologies and drugs being developed and/or commercialized by smart management teams and then invest in the associated companies at the right time and price. Over the last twenty years, we have seen and reported on some of the remarkable progress in improving the quality and durability of patients’ lives. Throughout this time there has been widespread agreement about the novelty and impact of these new drugs, products and related services, but there also has been legitimate concern about the associated dollar cost, particularly in the U.S., to both individuals and society. The result has been the promulgation of numerous proposals to dramatically change or even replace the current healthcare insurance/delivery system, at least in the United States. A popular U.S. theme reprised with vigor of late is to replace the current U.S. healthcare delivery system, which is largely employer based. A most common proposal is a centrally managed, single payer system which would presumably define benefits and premiums for recipients, as well as reimbursement/payments for providers, manufacturers and distributors. Given the current national conversation about this and the potential impact of such change in the U.S., the largest global pharma/biotech market, we have developed a view of the likely outcome and its impact on our investing approach.

We conclude that there may well be some near-term volatility in our sector rising from the recent proposals, particularly as we approach the presidential election later this year. However, beyond this period, we don’t foresee dramatic change in how healthcare works in the U.S. While Americans see issues with healthcare cost, coverage and quality in general, a significant majority of U.S. adults rate both their own healthcare coverage and the care they personally receive as Good or Excellent (Source: Gallup). In addition, the rate at which healthcare spending is growing has declined in recent years (Source: American Medical Association). Furthermore, as we have previously noted, healthcare comprises almost 20% of the U.S. economy and a complete replacement would be tumultuous. The combination of these factors does not suggest to us any fundamental change in the near term. Rather than sweeping change, we expect that there will continue to be modest or moderate changes to address specific issues. As a result, we do not conclude the need for a major change in our investing approach. We incorporate market, sentiment and cost related factors, but our fundamental approach to investing will continue to emphasize differentiated products and talented management.

Having said this, given the breadth of the healthcare sector, there will always be macro and micro factors that make us more or less confident in the short-term prospects of the healthcare sector or one of its subsectors. In recent months, for example, the sector has seen increased volatility relative to other times and has underperformed the broad S&P 500® Index* (“SPX”). This makes us a bit more cautious than usual. But as UBS Financial Services (“UBS”) noted in mid-year 2019, the healthcare sector, which often trades at a premium to the broad market, was trading at a wider discount to the broad market than it had in quite some time. UBS also noted the long-term consistent quality of healthcare earnings history and pointed out that, unlike the broad SPX market, forward earnings estimates for the healthcare sector have not been negative in any of the last 20 years. As you might expect, these factors make us more positive toward the healthcare sector in the near and intermediate term.

With regard to micro factors, there are, as usual, both bearish and bullish factors. As an example, litigation involving opioid producing companies has been a negative of late, hurting individual company stocks and generally depressing sentiment and valuations in the specialty pharma and drug distributor subsectors. The hope is that a “global” settlement will lift valuations.

Novel approaches to product and service delivery hold both encouraging and cautionary possibilities. Retail giant Amazon, for example, continues to push deeper into healthcare. The Company remains a potential disruptor to traditional healthcare channel companies with a growing portfolio of medical supplies. The acquisition of PillPack gave Amazon mail order pharmacy capabilities which may well compete with traditional players. In addition, Amazon continues to advance its joint venture with Berkshire Hathaway and JP Morgan which aims to reduce healthcare costs for employees. While these developments are seen by many as threatening the status quo, we continue to see opportunity in the form of new entities that seek to change how various aspects of medical and related sector (e.g., consumer) products are delivered to consumers. Our view as always is that the market is evolving and that traditional players that can evolve with it will prosper and that those that don’t won’t. We endeavor to invest in the former and divest the latter.

In addition, the development and commercialization of biosimilar drug products continues to move forward, providing an opportunity to reduce the cost to payers and patients of biological products that have lost proprietary status. A new group of companies has been built for the purpose of competing with traditional pharma and biotech entities. Interestingly, a number of traditional pharma players have developed their own subsidiaries aimed at competing in the biosimilar market. We think these developments will drive both quality and cost effectiveness.

Clinical trial successes and failures continue to both excite and disappoint the market. Among recent successes, we have seen cardiovascular benefit demonstrated by two new products. Amarin Corporation plc’s Vascepa has demonstrated a mortality benefit and The Medicine Co.’s gene therapy product has demonstrated a differentiated way to reduce cholesterol. Furthermore, and surprisingly to many, after an apparent failure in early 2019 that hit the biotech sector hard, it may well be that an anti- amyloid antibody developed by Biogen, Inc. can have a beneficial impact on Alzheimer’s disease. Balancing these positive developments there have been, as always, a few results that disappointed us in 2019. These include Gilead Sciences, Inc.’s recent NASH trial, Novavax, Inc.’s RSV trial and Allergan plc’s recent trial in major depressive disorder.

Probably the most encouraging development in recent quarters has been an apparent increase in the rate of successful merger and acquisition activity. After some initial uncertainty, the megamerger of Bristol-Myers Squibb and Co. and Celgene Corp. has been completed. We are also encouraged by the expected acquisition of Allergan by AbbVie, Inc. and the merger of Mylan N.V. with Pfizer, Inc.’s generic drug unit.

As always, we thank you for your consideration of the Tekla Funds. Please contact our servicing partner, Destra Capital Advisors LLC or us if you have any questions.

Destra Capital Investments is providing this update with permission from Tekla Capital Management. No offer or solicitation to buy or sell securities is being made by Destra Capital Investments.