BB Healthcare Trust (BBH) is a highly actively managed trust, seeking to exploit a long-term secular growth theme. The managers (Paul Major and Brett Darke) invest in a concentrated portfolio of companies providing new approaches to transform what they view as fundamentally broken healthcare systems around the world.
Using the closed-ended structure, Paul and Brett aim to take a longer-term view than the market. That said, the pandemic has shone a light on trends that they have long thought likely to emerge. As we discuss in the Portfolio section, the experience of seeing a GP during lockdown shows the potential for the NHS to save significant amounts of money on ‘digital first’ consultations, illustrating how models of care might soon shift very significantly to the benefit of many of BBH’s portfolio companies.
That said, the managers’ valuation-aware approach to growth investing means they are currently cautious, as evidenced by the portfolio’s defensive positioning and cash levels of c. 9% (see Gearing). The team believe capacity on the supply side (especially elective operations that can be easily delayed without risk to the patient’s life such as hip or knee replacements), and a longer time than people expect to ‘return to the norm’, will lead to some companies’ revenue and earnings expectations being revised down over the near term.
BBH targets a Dividend payout equal to 3.5% of the prior financial-year-end NAV. This dividend is funded from capital reserves, and the current target of 6.03p equates to a dividend yield of 3.2%. The strong Discount control mechanism (an annual redemption option every November), as well as good demand for the shares, has meant BBH’s shares usually trade close to NAV. It has been issuing shares this year, meaning we expect the ongoing Charges to be marginally lower this year than last year’s 1.19%.
BBH’s managers, Paul and Brett, are specialists in what is a complex field. It is an area of the market that in our view offers highly attractive secular growth opportunities, which are likely to prove resilient and to some extent unlikely to be derailed by the economic cycle. The team employ a highly active approach to stock-picking on a global basis, with a very concentrated portfolio.
As we discuss in Performance, returns since the December 2016 IPO have been strong, and are ahead of the trust’s twin objectives. Despite the various macro headwinds all investors had to contend with, 2020 saw a continuation of this strong performance, with BBH performing significantly ahead of the benchmark and its directly comparable investment trust peers, which we think amply demonstrates the resilience of the strategy even in the most challenging of market conditions.
In our view, the differentiated investment approach and highly concentrated portfolio have been key contributors to this sustained success. The statistics bear this out; whilst BBH’s NAV volatility has been higher than peers (making it more suitable for long term investors), the superior Sharpe ratio demonstrates that the managers continue to use this extra volatility to good effect for investors.
Aside from performance, BBH has several shareholder-friendly features including low discount volatility, high dividend security and a simple and transparent fee structure. Over the short term, BBH’s positioning arguably offers an interesting exposure to benefit from a post-pandemic recovery, without the risks that other ‘defensive’ sectors (such as consumer cyclicals) present.
|Highly differentiated offering, with highly active approach
||Narrow focus, and concentrated portfolio presents risks relative to more diversified portfolio
|Strong track record, added to over 2020
||Dividend based on NAV, which means that if the NAV falls year on year, it could mean a decline (although the board could choose not to pay a lower dividend)
|Attractive dividend yield (albeit paid from capital)
||Potential to gear, combined with concentrated portfolio, can translate into high NAV volatility
BB Healthcare Trust (BBH) is a highly actively managed trust, seeking to exploit innovation and change (healthcare efficiency) within a long-term secular growth theme (rising healthcare demand). However, whilst still exposed to strong growth themes, the managers’ more cautious view currently means that the portfolio is positioned relatively defensively. It is interesting to note this has resulted in continued outperformance compared to the healthcare benchmark in December 2020 and January 2021 even as the market has pivoted to more of a ‘risk-on’ theme around post-pandemic re-opening.
The managers’ long-term thesis is that modern healthcare needs (and budgets) are increasingly unsuited to the historic ways that these services have been delivered. As a result, BBH invests in a relatively concentrated portfolio of companies which the managers believe are playing a key role in re-inventing the entire healthcare eco-system.
Fundamentally, companies which can help western governments provide better healthcare solutions at lower costs (perhaps by doing things differently and/or incorporating technology) look more likely to succeed over the long run, but also have a long pathway of growth ahead of them.
By investing in companies that provide solutions to the key bottlenecks in the healthcare system, this should improve both care quality and effectiveness, freeing up resources to be redeployed elsewhere. Using the closed-ended structure, they aim to take a longer-term view than the market, aiming to invest for between three and five years, based on a five- to seven-year cash flow and earnings outlook.
The pandemic has given an early view of how the managers’ thesis fits, and what might evolve over the longer term. For example, the experience of seeing a GP during lockdown shows the potential for the NHS to save significant amounts of money on ‘digital first’ consultations, and illustrates how models of care can shift very significantly given the willingness (or need) to adopt alternative approaches.
‘Digital first’ is something the managers have championed for several years, but it also demonstrates their discipline: the fund currently has no exposure to Healthcare Technology, having sold out due to frothy valuations. In our view, this discipline in sticking to a fundamental framework augurs well for the trust’s ability to manage risk through market cycles.
Similarly, the pandemic highlights how capacity constrained hospitals are and should only be occupied by those in the most acute need. In any event, in more normal times, patients generally wish to minimise a hospital stay, and only stay there as a last resort. A key theme for the managers is connected care, enabling patients to remain at home with passive sensing technology that enables and enhances physician decision-making without the need for lengthy hospital stays. The increasing usage of these technologies would clearly be a win-win for both patient and providers, and enable acute treatment to be significantly more efficient and effective.
As we discuss in the Performance section, it is not only the portfolio that differentiates BBH from peers – but NAV returns too. Over the four years that the trust has existed, according to Morningstar data, BBH has outperformed comparable investment trusts (Worldwide Healthcare and Polar Capital Global Healthcare) by a considerable margin. 2020 (and early 2021) has seen the strong performance continue with the managers increasingly active on a turnover basis. Indeed, the managers tell us that their valuation aware approach to growth investing has led to turnover running at nearly twice the level of previous years (turnover of 14% in 2020, compared to the average of 8% in the prior years (Source: Bellevue Asset Management)). In our view, the concentrated portfolio and high conviction approach is a key differentiator when compared to peers, which have a larger number of portfolio holdings and consequently lower active share.
Portfolio turnover this year has been a reaction to both the rapidly changing outlook and pockets of high valuation. The trust’s managers, Paul Major and Brett Darke, are fundamentally growth stock pickers but who have a strong valuation input to their process. As the graph below shows, this has seen the trust’s underlying exposure evolve quite significantly as the year played out.
They believe that by pivoting the portfolio at times like this – trimming or selling stocks which they view as being over-valued and buying companies which have fairer valuations – they can stay ahead of the pack in performance terms and the trust’s unconstrained investment mandate gives them considerable freedom to do so, whereas many other healthcare-focussed investment trusts have restrictions around the types of companies they can hold, or the proportions of different sub-sectors of healthcare to which they are exposed.
This year’s experience of performance relative to peers suggests this was the correct strategy to have employed. For example, at the end of 2019 the team were heavily invested in diagnostics businesses (16.9% of NAV in November 2019). With the onset of COVID, the market pushed valuations for these companies significantly higher, and the team reallocated capital into areas such as essential services (such as remote monitoring, managing organ transplant patients) and drug companies supplying critical medicines for serious conditions (such as epilepsy, multiple sclerosis, cystic fibrosis and cancer). These are precisely the sort of areas where COVID is least likely to have a material impact on the revenue outlook.
EVOLUTION OF PORTFOLIO
It is important to note that the managers do not restrict themselves to companies which are strictly in the healthcare sector and, in the same vein, also take a truly multi-cap approach. They pay no attention to the composition of the benchmark. The mandate constrains the trust to a maximum of 35 stocks at any one time with 29 currently being held. They see the broader industry as their potential investment universe, including as it does companies within industries such as: pharmaceuticals; biotechnology; medical devices and equipment; healthcare insurers and facility operators; information technology (where the product or service supports, supplies or services the delivery of healthcare); drug retail; consumer healthcare; and distribution.
The top ten holdings which we illustrate below shows how the high conviction approach translates into the portfolio. It is worth noting that the weightings are higher than one might experience with a more diversified equity fund, which presents risks as well as opportunities.
TOP TEN HOLDINGS
|Bristol Myers Squibb
Source: Bellevue Asset Management, as at 31/01/2021
The managers tend to eschew the diversified mega-cap companies that account for the bulk of the weightings in the benchmarks and amongst many of the open- and closed-ended peer-group funds. That said, BBH’s largest holding is Bristol Myers Squibb, and represents a rare foray into mega-cap pharmaceuticals because of what the managers see as its highly attractive valuation currently. Paul and Brett observe that some exposure to larger companies can also be useful from a portfolio-construction perspective. Currently 94.9% of the portfolio is listed in the US, 2.2% in Europe and 2.9% in Asia. Currencies are not hedged, so UK investors will bear risks to underlying exchange rates.
As we discuss in Gearing, the team approached the end of 2020 with c. 10% cash on the balance sheet, mindful of Brexit not having been resolved but also the US election not having been fully resolved due to the State of Georgia. This contrasts with BBH’s historic level of gearing which has averaged 2.7% since launch. Latterly, the team have been putting cash to work in what they see as lowly valued health insurance stocks, which have suffered with the prospect of the Biden presidency. In their view, Biden has a divided nation to govern and needs to bring 50% of the population with him. They believe that the incoming administration is unlikely to press for radical change to the provision of healthcare in the US and, in this term of office, Biden does not have a mandate to impose negative reforms from the perspective of the industry. In this regard, Paul and Brett are actively looking to deploy the cash balance they have built up as valuations and opportunities allow.
That said, they are moving slowly, believing that expectations from many investors on a ‘return to normal’ from the pandemic were too optimistic at the beginning of the year. The team believe that the V-shaped recovery will take longer to achieve, not least because capacity on the supply side (think elective knee operations) will not be able to cope with the pent-up demand that results even after vaccines have been fully rolled out (which in their view will in any event take longer than many people anticipate to translate into a reduction in the day-to-day restrictions that we must all currently live with).
BBH is expected to be fully invested for most of the time, but the managers have latitude to operate within the range of a maximum of 20% gearing and 10% net cash. Over time, as the graph below illustrates, the trust has typically been modestly geared, and has averaged 2.7% since launch in late 2016 (based on month end data). The maximum level of gearing so far deployed has been 12% of NAV.
The managers see gearing as a tool that can be deployed to improve returns over time and, equally, for cash to be used defensively to protect investors’ capital during periods of volatility or de-rating. As such, they deploy leverage based on bottom-up opportunities, as well as on top-down views.
Reflecting continued caution on market valuations in certain areas of their universe, the managers currently have net cash of 8.6% (as of 31 January 2021). That said this is down from 10% at the year end and, as we note in the Portfolio section, the managers have latterly started to put cash to work in selected opportunities that meet their valuation criteria.
BBH’s investment objective is to provide capital growth and income over the long term. More specifically, its return objectives are:
- To beat the total return of the MSCI World Health Care Index (in sterling) on a rolling three-year period
- To seek to generate a double-digit total shareholder return per annum over a rolling three-year period
Given the trust floated on the London Stock Exchange on 2 December 2016, judging whether the trust has technically hit its objective has only been possible since December 2019 (i.e. three years since launch). As the graph below illustrates, on a rolling three-year basis, it is significantly ahead of the objectives on both fronts. As one might expect, the mayhem in early 2020 meant that the trust briefly fell behind its objectives, but is now back to being comfortably ahead of the relative target (i.e. ahead of the benchmark) and also ahead of the absolute target (10% per year). As we discuss in the Discount section, in our view it is this strong performance and differentiated offering that has enabled the trust to maintain its slight premium rating and thus to keep issuing shares since launch.
3 year rolling TOTAL RETURNS SINCE IPO
The graph below shows performance on an absolute basis relative to peers and the benchmark. We also include the S&P 500, which illustrates how the healthcare sector has performed relative to the broader index (effectively in-line over the period). BBH’s NAV total returns since IPO have therefore been strong relative to both. We believe it is noteworthy that BBH has performed in-line with the investment trust peer group, which includes several much ‘growthier’ peers. BB Biotech (another Bellevue-managed vehicle) and Syncona – offer very different (and by some definitions, more focussed) exposures. BB Biotech and Syncona are both well north of £1bn and hence skew the weighted average index. In our view, in an environment which has rewarded unprofitable growth stocks, it is credit to the managers that they have performed in-line with the peer group. As we note in the Portfolio section, the managers believe that the BBH portfolio has significant growth potential, but in areas which they believe should exhibit defensive characteristics in the current environment.
TOTAL RETURNS SINCE IPO
With what in our view is quite an impressive target over the long term, we think it is notable that BBH has performed ahead of the target since launch, but it is also notable how far ahead of the target the trust currently is. 2020 has been a defining year and, as the graph below shows, the managers have extended their lead over their twin investment objectives during the year. Aside from beating the benchmark, BBH has also beaten its two direct competitors, Worldwide Healthcare (WWH) and Polar Capital Global Healthcare (PCGH).
We observe that BBH has a more concentrated portfolio than these other two trusts, which may be the reason that it fell by further than these peers during Q1 2020. This serves to highlight the higher NAV volatility characteristics BBH has, making it suitable only for longer term investors in our view. Over three years, BBH has NAV volatility of 23.9% vs WWH’s 19.5% and PCGH’s 17.3%, according to Morningstar. This compares with the benchmark volatility of 13.2% and the S&P 500 of 15.5%.
PEER-GROUP NAV TOTAL RETURNS
Whilst higher volatility is something to be aware of, in our view it is likely to be a result of the combination of having a very active manager (benchmark-agnostic) as well as a concentrated portfolio and also potentially a function of foreign exchange volatility. Over the long run, such a portfolio might be expected to have a higher volatility, but also (assuming the manager is able to add value) to create outperformance relative to the benchmark. According to Morningstar, BBH’s Sharpe ratio over three years is 0.73, ahead of WWH’s 0.65 and PCGH’s 0.51. In our view, this shows that the managers are adding more value than peers, which more than offsets the extra volatility engendered by the concentrated portfolio and stocks they pick.
BBH has a total-return objective, with a proportion of returns provided to shareholders in the form of a dividend. We understand that the running yield of the portfolio is relatively low (c. 0.5 – 0.6%) in view of the growth characteristics of a majority of the underlying companies. The costs of running the trust mean that effectively none of the income is therefore available for distribution as a dividend. However, BBH targets a dividend payout equal to 3.5% of the prior financial-year-end NAV. This dividend is funded from capital reserves, created by cancelling the share-premium account and creating special distributable reserves out of which dividends can be paid.
The graph below shows that the dividend has been steadily increasing every year, and it is worth noting that it is paid in two equal instalments. The board calculates a dividend target for each following year based on 3.5% of the year-end NAV (at 30 November), and this figure is published shortly after the year end. This gives shareholders a good amount of visibility and, being paid from capital, gives them reassurance at times like this when sources of dividend income are looking shaky elsewhere. That said, because the dividend is calculated as a proportion of the year-end NAV, it is possible that the dividend could fall if the NAV has also fallen.
Whether the board chooses to override this and provide a progressive dividend in such an eventuality is so far unproven, although we are told that it has been discussed by the board, and the merits of maintaining a progressive policy by paying at least a flat dividend year on year are well understood. For the last financial year ended 30 November 2020, we understand that the board is intending to propose a final dividend of 2.5p per ordinary share to be paid in April 2021, making the total 5p.
The board is currently targeting 6.03p per share for the current financial year, which at the current share price would yield 3.2%. The board intends to declare an interim dividend of 3.015p (half of the target total dividend) in July 2021 to be paid in August 2021. The final dividend will be proposed in February / March 2022 and paid in March / April 2022. There is also the option to elect for a scrip dividend, for those who would prefer it.
Paul Major and Brett Darke co-manage BB Healthcare Trust. Paul has worked in healthcare-related finance for more than 24 years. For the majority of his career, he has worked as a sell-side research analyst, but has also worked in corporate finance. Initially at UBS, he then worked at Redburn for 13 years. He joined Bellevue in May 2016 in his first buy-side role in order to launch BB Healthcare. In September 2017 Paul was joined by Brett Darke, who similarly has a medical and healthcare background, having previously spent 11 years on the buy side at TT International and also having worked in healthcare corporate finance. The two have known each other professionally for a number of years and they both work from London. The BB Healthcare strategy is their sole focus.
Bellevue Asset Management is a Swiss asset-management company listed on the Swiss stock exchange, which has grown from being a specialist healthcare-investment boutique to providing many other strategies for clients around the world. In total, Bellevue now manages £10.3bn, of which c. £8.2bn is in healthcare strategies. The firm has another investment trust – the Swiss-listed fund BB Biotech (BION). Paul and Brett can draw upon the experience and resources of a wider team of 18 healthcare investment professionals, managing 16 different healthcare-focussed strategies.
BBH aims to minimise discount risk for shareholders and ensure that over anything other than the short term the trust does not trade on a material discount to NAV. In order to manage the discount, the board employs a strong discount control mechanism which, as the graph below illustrates, has led to very low discount volatility – in absolute terms but also relative to comparator trusts. BBH has an annual redemption facility for 100% of shares in issue at year end, the redemption point being the last business day of November each year. At the last redemption point in November 2020, the board received redemption requests for 565,413 shares (representing 0.11% of the shares in issue at that time). At that time (and as in prior years), all of these shares were matched with buyers and so there was no change to BBH’s share capital.
As with any investment trust, the discount can blow out over the very short term with this sort of discount-control mechanism. This was witnessed during the very volatile markets during March this year, despite the trust continuing to make daily NAV announcements. According to Morningstar, the discount widened to c. 10% between 17 and 19 March 2020, before narrowing back to a premium on 23 March. That said, BBH has traded on a consistent premium rating, reflecting (in our view) the strong performance delivered by the managers and the differentiated investment proposition.
This has enabled the trust to issue shares on a regular basis at a small premium to NAV. Over the 2020 calendar year, for example, BBH grew its shares in issue by 13.9%. As we discuss in the Charges section, this has resulted in the OCF gradually declining over time, which (aside from the improved liquidity that a larger size can bring) is a major benefit to existing shareholders. The shares currently trade on a premium of 1.9%.
PREMIUM / (DISCOUNT) TO NAV
BBH pays a flat management fee of 0.95% per annum on the market capitalisation of the trust. This aligns the managers with shareholders and helps incentivise them to prevent the shares trading on a discount for any period of time. It also deals neatly with the question of gearing, with the managers not incentivised through the fee to employ gearing (which might be the case if fees were based on gross assets). It is worth noting that the trust’s board is also fully remunerated in shares, and these are locked up for a minimum period of three years after issuance.
There is no performance fee payable. BBH has grown to become a relatively large trust, with net assets of c. £930m at 25/01/2020. As we note in the Discount section, the trust has been a regular issuer of shares which, combined with organic growth, has meant it has continued to grow substantially. The new OCF figure will be published with the annual report expected at the end of February 2021, and we expect to see a further continuation of the decline in the OCF that we have seen over the past years.
The historic OCF (for the year ending November 2019) was 1.19% and compares favourably with the simple average of the peer group of 1.32%. That said, Worldwide Healthcare (with net assets of c. £2.5bn) has an OCF of 0.9% (although it does have a performance-fee, which could take the OCF up meaningfully in certain circumstances). Under BBH’s current fee structure, the fixed elements add up to c. 1.1%, and so the decline in the OCF is unlikely to decline at the same rate if BBH extends its grow trajectory. We continue to believe the best way for the trust to remain competitive would be if the board were to secure a tiered management-fee structure, a feature which has become much more prevalent in the investment-trust universe in the past few years. The latest KID RIY is 1.30%.
ONGOING CHARGES OVER TIME
Bellevue Asset Management is a signatory to the UN Principles for Responsible Investment (UNPRI). The company has a centralised ESG team who work with managers on each strategy to integrate ESG analysis into all aspects of the investment-management process. As such, Paul and Brett take ESG factors into account when making investment decisions. This is especially relevant given the managers invest on a long-term (three- to five-year) time horizon, where ESG risks can weigh on the long-term sustainability of a company.
Given the emphasis on healthcare, we think BBH could be positioned in portfolios geared towards the social aspect of ESG. The underlying thesis of the trust is well aligned to this – the managers aim to invest in companies providing new approaches to what they view as fundamentally broken healthcare systems around the world, changes which would clearly be to the betterment of society as a whole. However, the team do not have a negative screen for investments, and so very strict ESG mandates may not be able to include BBH in portfolios. That said, we think many of the companies the trust invests in are helping to bring more affordable healthcare to more people, and it could therefore suit other investors who have a less strict definition of ESG.
Attempting a quantitative ESG analysis of BBH, Morningstar’s coverage only extends to c. 33% of the portfolio, illustrating the drawbacks of niche-managers who have a multi-cap approach and the current deficiencies of such quantitative ESG assessments. As such, the trust does not have a sustainability rating.