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David Kimberley
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Updated 29 Sep 2023
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This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

At least in theory, few sectors should enjoy secular growth like healthcare and biotech. We all need to go to the doctor, the world is getting older, and the ability of governments to pay for healthcare services is being squeezed. The result is growing demand combined with a compelling reason to innovate.

And yet healthcare stocks and the biotech sector have, much like other parts of the market, had a tough couple of years, with share prices coming down from their pandemic highs. Although it has seen a recovery in the last twelve months, the NASDAQ Biotechnology Index is still below the levels it was trading at in September 2021.

To be fair, the pandemic fuelled a lot of speculative investment in biotech and healthcare stocks. The wider boom in firms issuing equity and going public also brought some companies to market that may not have done so in more ‘normal’ market conditions.

However, Ailsa Craig and Marek Poszepczynski – managers of International Biotechnology Trust (IBT) – have argued that investment in the biotech sector comes in cycles, with overexuberance unsurprisingly followed by a downturn that leads to more M&A activity, which in turn starts the cycle of improved valuations and more capital flowing into the sector.

Speaking to Ailsa earlier this month on our podcast, she noted that the IBT portfolio has benefitted from M&A activity, with six companies in the portfolio being picked off. Ailsa also added that companies which are producing good data and financials are being rewarded by the market for doing so, whereas poorer quality firms are finding life much tougher.

Nonetheless, we are far from being in the boom cycle. As we noted in our most recent note on IBT, the sector remains out of favour and valuations are low compared to their historical average.

It is a slightly different story at the top end of the healthcare market. Often seen as more defensive, big pharmaceutical companies Novo Nordisk and Eli Lilly have enjoyed a surge in their valuations on the back of developing new obesity drugs.

Bellevue Healthcare (BBH) managers Brett Darke and Paul Major have done an excellent analysis of this in their most recent factsheet, essentially arguing that the benefits of these drugs are questionable, there is likely to be a price war that will bring down margins anyway, and that predictions about their impact on other health problems – heart disease for example – are spurious. Despite this, both of the aforementioned companies continue to trade at very high valuations.

The knock-on effect of this has been to make it harder for the BBH managers to have short-term outperformance. That does tend to happen when you don’t jump on the latest bandwagon.

BBH now sits at a -8.1% discount as at 29/09/2023. This is a trust that sat on an average monthly premium for the majority of the time  from the start of 2017 through to the end of 2021. Even accounting for the discount widening this year, the trust’s average discount since inception in 2016 remains at -0.1%.

The past couple of years have shown that further volatility can never be ruled out. Plagues, wars, economic disaster – we look forward to whatever happens next. Nonetheless, BBH and IBT are both out of favour, despite the positive long-term trends that back their investments. Assuming positive results come through and some of the froth at the top end of the market is filtered out, then it’s plausible performance will follow for both trusts.

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