Gearing up for recovery

It has been an interesting start to the year for equity investors, particularly when one considers what went on in the year before.

The MSCI ACWI gained almost 20% in 2021 – a year during which the British government made ‘going on holiday’ illegal, the Suez Canal was sealed up by a ship like a 20,000 tonne cork in a bottle, and the US Capitol was besieged by rioters led by a man dressed as a buffalo.

Yet this year, with Coronavirus firmly in retreat, the same index has lost 4.6% and technology stocks have entered ‘correction’ territory. The Nasdaq 100 lost more than 10% between New Year’s Day and 15 February 2022.

This apparent irrationality of markets is emphasised by the way that biotechnology companies, despite the role they played in saving the world, shared no significant part of the upside of last year’s strong performance, and have tanked with everything else since this year began.

The Nasdaq Biotechnology Index gained just 0.94% in 2021, and has lost more than 12% since the market re-opened in January.

Inflation, clearly, has rattled markets and sabre rattling in Eastern Europe is adding to investors uncertainty about the future. What, then, to make of this as we stare into the fog of war?

For the team at BB Healthcare (BBH), an investment trust focused on generating capital growth via a globally diversified portfolio of healthcare companies, the message is one of optimism for the future tempered by the acknowledgement of volatility in the near term.

“The COVID-19 pandemic is unarguably moving into an endemic phase,” says fund manager Paul Major, who runs the portfolio alongside co-manager Brett Darke. “There is still a huge amount of liquidity in the global monetary system and corporate balance sheets are in rude health relative to historical norms regarding leverage ratios and funding costs.

“However, other asset classes, especially sovereign bonds and property, are unattractive at this time due to rising interest rate expectations and changes to how we live and work. All of this is arguably supportive for equities in the longer-term.”

He continues: “Trying to be measured then, we see a gradual increase in the risks to certain areas of the economy, but nothing that would warrant such a violent sell-off as we saw in January.”

Against that backdrop, and cognisant of the bumpy ride which shareholders in the trust have had in recent months and which is likely to continue in the short term, the team have moved to a bullish footing, increasing gearing and adding incrementally to their existing holdings where value has emerged.

“We firmly believe that history will look back on this moment as a fantastic relative opportunity for long-term healthcare investors. Even the most recent market low in March 2020 only saw a 16% decline over the first quarter of that year, as the market grappled with the consequences of the rapidly unfolding pandemic.

“The market can have irrational periods and how one chooses to respond to those can add material value for investors. If you really think that asset prices are wrong (in either direction), then you should be taking advantage of that.”

Investors have continued to back the trust, which saw inflows (through share issuance) of £18.6m during January, and all of this has been invested while net borrowings have increased by £35m at the same time. Seventeen of the trust’s positions have increased in size, and among those six have grown by more than 20%. As well as adding to existing holdings, the team have added three new ones – one each in the Tools, Diagnostics and Medical Technology sub-sectors. The total number of holdings now stand at 33, reflecting the managers’ intention to manage a concentrated portfolio.

The team’s bullish view on the long term outlook is matched by a realism on what they, and their investors, will have to get through to get there.

“There is a common misperception that market panics unfold quickly and decisively. Looking back to recent market corrections such as Q4 2018 or Q1 2020 would affirm this view, but ‘market correction’ is an interesting choice of terminology; it implies a rationality or higher purpose to market behaviour that is often lacking, and these things can go on for much longer than one may realise.

“With that in mind we cannot be confident that the mid-cap healthcare rout is close to its denouement, but we can objectively discern value when we see it, and that time is now. To that end we approach the springtime with a portfolio of undiminished quality and an unchanged investment strategy, but one that is re-weighted to take maximum advantage of any return to more typical market dynamics and enhanced with an increased level of gearing that reflects our conviction in the opportunity that lies before us.”

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