The Business of Medicine

June 9, 2015

Physicians have an insider’s view of the healthcare sector, and those who invest in it understand how healthcare companies can deliver strong financial performance. In the 12 months to March 31, 2015, the S&P 500 Health Care Index returned 24.2% in U.S. dollars, the S&P/TSX Canadian Health Care Index delivered a 28% return, and the MSCI World Health Care Index returned 39.6%, in Canadian dollar terms.

“The recent performance of the healthcare sector has been strong, but healthcare stocks find their way into our funds and pools as a result of each company’s unique risk-return profile,”

All three indexes outperformed their broader markets. However, it’s the ability of the global healthcare sector to consistently outperform over the long term that is the real story.

“The recent performance of the healthcare sector has been strong, but healthcare stocks find their way into our funds and pools as a result of each company’s unique risk-return profile,” said Craig Maddock, Senior Portfolio Manager and Vice President of Investment Management at MD Financial Management. “While we are part of the Canadian Medical Association, we do not manage the funds to specifically target investments in healthcare,” he added.

Health Care Set to Ride Positive Trends

Caring for increasing numbers of seniors is a challenge to healthcare systems and physicians around the world. Seniors are perhaps the single most important driver of growth in the global healthcare market. As people live longer with chronic disease, the push to develop new ways to care for them will only grow. Wealthy seniors in particular could spend disproportionate amounts of money on pursuing healthcare solutions.

The emerging field of personalized medicine could open a whole new world of investment opportunities. Personalized medicine, which has grown out of innovations in genetic testing, is the customization of health care. It sees medical decisions, practices and drugs tailored to the individual patient.

Health Care Can Help Reduce Volatility

Parts of the healthcare industry can play a defensive role in portfolios while offering solid return potential. Unlike a more cyclical sector that is tied to economic growth, like the airline industry, spending on health care tends to grow year over year. Market analysts describe it as non-discretionary spending. Other parts, such as biotechnology, offer opportunities for above-average returns with the increased risk that comes with leading-edge innovation.

Consider that in the 10 years ending Dec. 31, 2014, the healthcare subsector of the Russell 1000 Index posted annualized 10-year volatility of 12.9% versus the index’s overall 15%. (The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. The index represents about 92% of the U.S. market.) With health care removed from the Russell 1000 Index, it would have had annualized volatility of 15.7%. In other words, healthcare returns have been more predictable, allowing them to be used to mitigate some of the volatility within a portfolio.

Health Care Offers Built-In Diversification

Physicians know that providing health care is fraught with challenges and complexity. And for that very reason, health care offers investors a wide variety of options. It’s a sector that includes small biotech startups and Fortune 500 companies, leading-edge pharmaceuticals and generic drugs, and the bricks and mortar of private hospitals alongside private insurance providers.

The intersection of technology and health care also offers investors ways to diversify their portfolios. Novartis, one of MD’s top 10 holdings (by market value), is using bold technology investments to maintain market leadership. Current projects include pills and inhalers with sensors that alert health providers when patients miss a dose. Novartis is using technology normally found in an Xbox to measure coordination in people with multiple sclerosis. Detecting diabetics’ blood-sugar levels in their tears may also be possible by embedding Google sensors in contact lenses.

“These kinds of diversified opportunities are very interesting–they provide a wide range of business models and product cycles to capitalize on the growing need for health care,” Maddock said. “Many of the external advisors we work with find compelling investments in the healthcare space to include in our funds and pools.”

Top 10 MD Healthcare Holdings

Company Market Value (C$) Domiciled
Valeant Pharmaceuticals International 70,001,502 Canada
Roche Holding Ag 45,723,993 Switzerland
UnitedHealth Group Inc. 41,869,593 United States
Novartis Ag 41,674,224 Switzerland
Catamaran Corp. 36,111,020 Canada
Novo Nordisk A/S 32,280,841 Denmark
CSL Ltd. 24,492,867 Australia
Essilor International 24,283,173 France
Astellas Pharma Inc. 22,066,504 Japan
Johnson & Johnson 20,848,366 United States

As at March 31, 2015.

MD Funds and Pools With Overweights to Health Care

Fund/Pool Average Weight Index Average Weight
MD American Value Fund 14.3% S&P 500 Index 13.3%
MD American Growth Fund 16.4%
MDPIM US Equity Pool 15.3%
MDPIM International Equity Pool 12.1% MSCI EAFE Index 10.8%
MD International Growth Fund 13.5%
MD International Value Fund 13.6%
MD Select Fund 4.9% S&P/TSX Composite Index 3.3%

For the 12 months ending March 31, 2015.

Healthcare Index Returns vs. the Broader Market (%)

  1 year 5 years 10 years
S&P 500 Health Care Index 44.9 25.5 11.9
S&P 500 Index 29.4 19.6 8.5
S&P/TSX Canadian Health Care Index 67.9 53.3 21.2
S&P/TSX Composite Index 6.9 7.4 7.4
MSCI World Health Care Index 39.5 23.8 11.6
MSCI World Health Index 22.5 15.8 7.6

Returns to March 31, 2015. All returns in Canadian dollars.
Sources: S&P, MSCI, Bloomberg.

Company Highlights

Combined, we currently invest in 89 healthcare securities with a market value in excess of C$750 million (at March 31, 2015) throughout the MD mutual funds and pools. Some of the highlights include Novo Nordisk, Johnson & Johnson and Valeant Pharmaceuticals.

Novo Nordisk

Novo Nordisk has been a long-term holding in MD Growth Fund and the MDPIM International Equity Pool. It is held by the fund advisor, Walter Scott & Partners of Edinburgh, Scotland. They typically look for companies they believe can achieve a growth rate of 20% or more in the future. Novo Nordisk historically was able to double the prices of some drugs, but has recently come under increased competitive pricing pressure, reducing the outlook for growth in the future. Not surprisingly, Walter Scott paid special attention to the impact of such a change on the future value of Novo Nordisk and on their conviction to remain invested.

Novo Nordisk is a global healthcare company with 90 years of innovation and leadership in diabetes care. It was founded in 1923, the same year Canadian physician Frederick Banting won a Nobel Prize in medicine for his pioneering work using insulin to treat diabetics. Novo Nordisk also has leading positions in hemophilia care, growth hormone therapy and hormone replacement therapy.

  • Headquarters: Copenhagen
  • Employees: 41,500
  • Market capitalization: $181.6 billion

Market news: Novo Nordisk is resubmitting its Tresiba insulin to U.S. regulators in a move that could take market share from Sanofi’s best-selling diabetes treatment, Lantus.

Valeant Pharmaceuticals

Valeant Pharmaceuticals is held within the MD Select Fund and MDPIM Canadian Equity Pool by advisor PCJ of Toronto. We use PCJ in our management of funds that have a focus on growth characteristics such as earnings momentum, return on equity and earnings per share. PCJ also considers the relative value within each sector. Given the very narrow opportunity set for healthcare in the Canadian equity marketplace, the investment in Valeant is primarily for its growth characteristics.

A few of the characteristics PCJ considers in the decision to invest in Valeant are:

  • A highly diversified product base, with no reliance on single products. This allows for a less volatile revenue stream.
  • Very few drugs on the patent cliff, which means limited competitive price pressure.
  • Earnings that have consistently surprised on the upside. The quality of earnings continues to improve, and free cash flow growth is substantial.
  • Gains from acquisitions that come from cutting cost redundancies, integrating products into a global platform and tax management.

Valeant Pharmaceuticals focuses on neurology, dermatology and infectious disease. It has several drugs in late-stage clinical trials and several currently on the market. Valeant sells a wide range of drugs, including over-the-counter medications and medical devices, as well as prescription drugs like antidepressant Wellbutrin XL. Kinerase, which uses kinetin as its active ingredient, is one of Valeant’s most popular products. Valeant also has a portfolio of more than 500 products, thanks to a company history that stretches back to the 1960s. It was originally a group of specialty chemical and radiochemical research, development and supply companies.

  • Headquarters: Laval, Quebec
  • Employees: 41,500
  • Market capitalization: $66.3 billion

Market news: In early April, Valeant completed a US$11.1-billion friendly takeover of Salix Pharmaceuticals. Valiant will seek U.S. Food and Drug Administration approval for Xifaxan, a new Salix drug to treat irritable bowel syndrome.

Johnson & Johnson

Johnson & Johnson is held in the MD American Growth Fund and by multiple advisors to the MD funds. The stock was recently added by Jensen Investment Management of Portland, Oregon. We rely on Jensen to provide a component of conservative growth through investing in companies that have delivered a return on equity in excess of 15% for each of the past 10 years. These businesses tend to be more stable and predictable.

Johnson & Johnson was recently reintroduced to the funds after it had been sold in 2011 in order to focus on other stocks. Jensen believes that in addition to its long-term growth rate, Johnson & Johnson benefits from powerful competitive advantages across its businesses. These advantages include size/scale, brand equity, intellectual property, and entrenched relationships with global healthcare organizations. Jensen also is impressed by the company’s revenue diversity, exceptional balance sheet (J&J is one of only three companies in the world with AAA credit ratings) and relatively stable end markets. Jensen expects Johnson & Johnson to grow steadily due to increasing global healthcare demand, new product development, and acquisition activity.

Johnson & Johnson is a globally diversified healthcare conglomerate with businesses in pharmaceuticals, medical devices and equipment, and consumer health care. It benefits from powerful competitive advantages across its businesses, including size, brand equity, intellectual property and entrenched relationships with global healthcare organizations.

  • Headquarters: New Brunswick, New Jersey
  • Employees: 128,700
  • Market capitalization: $275.7 billion

Market news: Johnson & Johnson announced that Ethicon, a medical device company in its family of companies, is collaborating with Google to advance surgical robotics.

Previous Article
Update on economic situation in Greece

On June 28, debt negotiations between Greece and its creditors broke down. Now, Greek Prime Minister Alexis...

Next Article
RRSP or TFSA: Which Is Right for You?

In an ideal world, you would contribute the maximum amount to both your RRSP and TFSA every year.