Janus Henderson: Healthcare: Boosting your defences?

The Portfolio Construction and Strategy Team explain why investors should consider a dedicated allocation to healthcare, which has historically captured less downside during market sell-offs.

Key takeaways:

• Healthcare has traditionally been an effective portfolio buffer during periods of volatility, with healthcare and the biotech subsector proving to be more insulated from the market drawdown in 2022.
• Expert knowledge is critical to identifying winners that can take advantage of the speed of innovation happening in the sector.
• We think an active and nimble approach is key to finding companies that stand to benefit from the long-term tailwinds that healthcare and biotech can provide.

Given the market volatility of 2022 and a slowing world economy, it is understandable that investors might want to tread carefully. Yet, such periods can uncover attractive investment opportunities, including assets with both defensive characteristics and growth potential. From a portfolio construction point of view, this translates into investments that can provide uncorrelated returns and help protect against drawdowns.

To that end, we believe investors could benefit from an allocation to healthcare. The sector has historically captured less downside during market sell-offs, and also benefits from structural tailwinds such as aging populations and rapid innovation. In 2022, for example, most global equity sectors experienced material losses (see Exhibit 1), yet healthcare broadly and the biotech subsector specifically were more insulated from the pain.

The question from a portfolio construction perspective is, why was that the case, and can we expect similar characteristics going forward?

Exhibit 1: Global equity sector returns for 2022

Source: Morningstar, global equity sectors and subsectors based on MSCI World Index, as at 31 December 2022. Past performance does not predict future returns.

Can healthcare provide immunity from the downturn?

Healthcare has traditionally been an effective portfolio buffer during periods of volatility due to steady consumer demand for hospitals, medicines, and medical devices irrespective of market conditions. This is true for approximately 85% of the sector, which is made up of pharmaceuticals, medical devices, and health care services, all of which reflect the “defensive” characteristic we mentioned earlier.

The remaining 15% of the sector is made up of biotechnology firms. This subsector includes innovative – and inherently volatile – small- and mid-cap firms that offer greater growth potential, as well as large-cap firms that reflect more defensive qualities and tend to behave similarly to traditional pharmaceutical companies.

Exhibit 2: Breakdown of the global healthcare sector

Source: MSCI, composition of the MSCI World Health Care Index as at 31 December 2022.

These defensive and growth characteristics are reflected in historical returns. Exhibit 3 shows the performance of the healthcare sector and biotechnology subsector relative to global equities (excess return) during the past five market drawdowns and subsequent recoveries. While we would expect healthcare to outperform across the full cycle of drawdown and recovery due to its defensive nature, biotech has ultimately shown better performance, highlighting its capacity for alpha generation.

Exhibit 3: Average excess return vs MSCI World for past 5 market drawdowns and recoveries since 2000

Source: Morningstar. Global equity sectors and subsectors based on MSCI World Index. Average of downturn periods are 1/4/00 – 9/10/02, 1/11/07 – 9/3/09, 3/5/11 – 4/10/11, 13/2/20 – 23/3/20, 5/1/22 – 12/10/22. Recovery periods are based on MSCI World, for the final period 31/12/22 in the case of the recent recovery. *Last market downturn period recovery and full cycle end date is as at 12 December 2022. Past performance does not predict future returns.

A specialist field requires active management

It is estimated that 90% of drugs that enter human clinical trials never make it to market, and for those that do, our experience shows that consensus sales estimates for new drug launches are wrong 90% of the time.¹ Therefore, expert knowledge and understanding of the scientific research, testing, and drug approval process, plus a skilful assessment of the related commercial opportunities, is critical to identifying winners that can take advantage of the speed of innovation happening in the sector.

At the same time, the market drawdown in 2022 caused a rerating of price-to-earnings ratios for healthcare stocks, with ratios dropping precipitously from recent highs. This rerating was particularly pronounced in the small- and mid-cap biotech space. In fact, roughly 200 of these companies now trade below the levels of cash on their balance sheets,²creating the opportunity for idiosyncratic events (e.g., positive clinical trial updates) to drive significant upside.

Therefore, we think an active and nimble approach is key to finding those companies that stand to benefit from the many long-term tailwinds that healthcare and biotech can provide, as well as uncovering opportunities borne out of market inefficiencies.

¹ American Society for Clinical Pharmacology & Therapeutics, “Probability of Success in Drug Development,” van der Graaf, Piet H., 19 April 2022.

² Rapport Biotech Insight & Opinion, as of 3 January 2023.

Important information

This document is intended solely for the use of professionals, defined as Eligible Counterparties or Professional Clients, and is not for general public distribution.

Past performance does not predict future returns. Marketing communication. The value of an investment and the income from it can fall as well as rise and investors may not get back the amount originally invested. There is no assurance the stated objective(s) will be met. Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell, purchase or hold any investment.

There is no assurance that the investment process will consistently lead to successful investing. Any risk management process discussed includes an effort to monitor and manage risk which should not be confused with and does not imply low risk or the ability to control certain risk factors.

Various account minimums or other eligibility qualifications apply depending on the investment strategy, vehicle or investor jurisdiction. We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.
 
Issued in Europe by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Henderson Investors International Limited (reg no. 3594615), Janus Henderson Investors UK   Limited (reg. no. 906355), Janus Henderson Fund Management UK Limited (reg. no. 2678531), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and  Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial  Conduct Authority) and Janus Henderson Investors Europe S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). Investment management services may be provided together with participating affiliates in other regions.

Janus Henderson, Knowledge Shared and Knowledge Labs are trademarks of Janus Henderson Group plc or one of its subsidiaries. © Janus Henderson Group plc.