Healthy profits don’t come without risks

Why wouldn’t you invest in healthcare? The imperative to ensure expanding and ageing populations worldwide remain healthier for longer is surely too big an opportunity to ignore. Just ask the Danish pharmaceutical giant Novo Nordisk, which made almost $4bn of profit during the third quarter of this year alone, largely thanks to blockbuster sales of its weight-loss drug Wegovy.

Still, while investing in health seems like an obvious move, history tells us that there is plenty of risk alongside all this opportunity. The biotech companies responsible for delivering the drugs of tomorrow have as many misses as they do hits. Political interventions can undermine the business model of the market overnight. Economic factors weigh heavily on an industry that constantly needs to invest for the future.

Recent years have seen these risks rise to the fore. The Covid-19 pandemic focused investors’ minds on the potential value of healthcare businesses, leading to a spike in their value. But this proved short-lived, with biotech companies in particular dropping like a stone in 2021 and 2022, as well as for much of 2023.

Earlier this year, we saw something of a recovery, with the S&P Biotechnology Index climbing 12% in the first two months of 2024. Since then, however, performance has flattened out; that index is now slightly down on where it stood at the beginning of March. Chatter about a biotech rebound had quietened by the summer.

Still, whisper it quietly, but there are now more good reasons to be optimistic about the year to come, as research just published by the investment trusts team at analyst Edison points out.

Above all, the economic backdrop is improving, with falling interest rates that will help the industry to raise money at affordable prices. The need for new drugs is more pressing than ever, particularly in the context of the “patent cliff” – the fact that so many drugs important to pharmaceutical companies are close to losing their intellectual property protections. M&A activity across the whole market is picking up, with healthcare expected to be a hotspot for dealmaking.

In this context, Edison’s team highlights “the sector’s resilience and potential for recovery following the Covid-19 pandemic and subsequent market corrections”. It also points out that “investment trusts offer investors a strategic way to gain exposure to the healthcare sector, while managing risks, through diversified portfolios and professional management expertise”.

It’s an important point. Investment trusts have a long history of providing investors with a route into healthcare, pharmaceutical and biotech businesses. Professional managers with experience of the sector build a spread of holdings on investors' behalf in an area where scientific expertise is often required to make smart choices about the companies to back.

Today, the AIC’s Biotechnology & Healthcare sector offers a choice of seven funds offering exposure to this area. Some are biotech specialists while others offer access to broader portfolios. But all are concentrated on healthcare themes of one type or another.

The structure of an investment trust offers vital protection here. In a sector where performance can be volatile, the danger of investing through an open-ended fund such as a unit trust is that you’re vulnerable to market panics. If large numbers of investors want out, the manager may need to sell assets at knockdown prices to meet redemption requests, and in extreme cases, withdrawals may even be suspended. In a closed-ended investment trust, by contrast, there is no such issue – stock market-listed shares offer uninterrupted daily dealings no matter what is happening to the value of the fund’s assets.

None of which is to advise betting the house on biotech and healthcare. But if you accept the long-term appeal of this area – the fact that the human population is desperately in need of new drugs and treatments – it makes sense to think about the right moment to take the plunge.

After a strong start to 2024, stock market-listed and privately-owned healthcare businesses have struggled to make progress. Now, however, with political uncertainty easing in markets such as the US and the UK, and with the economic headwinds of high inflation and elevated interest rates also slowing, opportunity knocks once again.

Most of the large pharmaceutical companies are facing patent expiries that threaten their profitability, warns research published by Leerink Partners this month. It says that firms such as Bristol Myers Squibb, Merck, Amgen, Novartis and AstraZeneca are all going to have to look to M&A to rebuild. Investors in target companies will benefit accordingly, and a wave of dealmaking could drive up the whole healthcare sector.