Health Care: A core sector in portfolio construct
- Health Care fits well in the secular growth theme of the CIO Barbell Strategy
With its good long-term fundamentals, the sector has delivered solid earnings and share price performance since the start of the decade (Figure 1). We remain constructive on the fundamental outlook as the investment thesis remains intact.
Importantly, the Health Care sector experienced a lower level of gyrations over cycles in recent years (Figure 2). For investors looking to build a diversified, long-term portfolio and to capture superior growth, Health Care is a sector which should be included.
Over time, we expect the sector’s valuations to return to premium in reflection of the its unique and superb fundamentals, which include resilience in earnings, global reach, and the inexorable march of health care firms’ research and development (R&D) that expands the total addressable market (TAM), and the fundamental importance of health care to existing and future generations in the years ahead. The discovery of antivirals, new remedies, and their availability to the general public will reshape the global health care industry.
Figure 1: Positive secular trend…
Figure 2: …and lower gyrations within cycles
A structurally important sector. Health Care is among the top weighted sectors and accounts for more than 10% in the global benchmark, the MSCI World Equity Index (Figure 3). Its stable and secular growth characteristic allows it to be highly favoured by investors and we believe it is a must-have sector in portfolio construct.
The diversity and size of the Health Care sector makes it easy to be included in any portfolio construct. It comprises the following sub-sectors: Pharmaceutical, Equipment, Biotechnology, Managed Health Care, Life Sciences Tools, Services, Facility Management, and Supply Provisions (Figure 4).
Figure 3: Health Care is an important sector in a global context
Figure 4: Pharmaceutical, Equipment, and Biotechnology are the major sub-sectors, led by companies from developed nations
Ageing population ratio is a long term trend. Demand for medical attention and services is also caused by the rising ratio of the aged population globally. The world has 730m people at or above 65 years as at end-2020, equivalent to 9% of the global population (Figure 5). This number is projected to reach 930m by 2028, an increase of 27% over the next eight years. The mammoth size of this group, most of which are Baby Boomers, will boost the strong consumption of health care-related services and solutions.
Figure 5: Ageing population ratio climbing
Patented drugs leading the pack. Industry leaders are well ahead of the competition in new drug developments. Generic drugs accounted for less than 10% of total revenue share globally and are projected to stay within that range (Figure 6). The majority of the revenue share are still within tight grip of pharmaceutical companies with branded and orphan drugs.
It is projected that patented and orphan drugs will continue to command a combined 90% revenue market share globally in the years to come, alleviating the overblown concerns on patent cliff.
Figure 6: Generic drugs are not a threat
Outlook. The Health Care sector is set to deliver long-term sustainable growth due to:
1. Ageing population and longer lifespan, giving rise to greater need for medical products and services.
2. Rising disposable income and greater allocation of disposable income to medical expenditure.
3. Continuous R&D leading to medical and technological advances, which expand the TAM in terms of treatment for more diseases and methods to better treat existing diseases
Recommendation. Health Care is a unique industry that will continue to enjoy stable revenue and earnings uptrend over economic cycles (Figure 7). This sector should be included as an integral part of a holistic long term core portfolio construct. Health Care stocks are trading at attractive valuations, with robust long-term earnings potential while being defensive in nature.
Since 2Q20, the valuation premium has reversed into a discount (Figure 8). We think this phenomenon should reverse as the sector consistently offers higher return on equity (ROE) than the global equities benchmark (Figure 9).
Figure 7: Solid earnings trend
Figure 8: Valuation discount to global equities to narrow
Figure 9: Consistently better shareholder returns
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