Wouldn’t you like to invest in something that
- Would have given you a nearly 3% higher yearly return than other stocks over the last two decades
- Is extremely likely to keep outperforming going forward because the fundamental trends driving it are only getting stronger every year
- Is pretty much recession-proof given that demand for it is inelastic
In that case you should consider allocating some of your portfolio to healthcare stocks, as these meet all of the above criteria.
Ageing populations that are increasingly middle class = more demand for healthcare
Let me start with some statistics for you to ponder over:
- Globally, the world population has been ageing. The number of people over 80 years old is expected to triple by 2050. By that time there will be 2.1 billion people over 60 years of age, partly due to the fact that the average life expectancy increased by 5 years between 2000 and 2015 alone
- Making matters worse, more doctors and caretakers will retire, leaving fewer people to care for more of us
- The global middle class is increasing rapidly as people lift themselves out of poverty. By 2021 for the first time more than half of the world’s population may be living on a middle class income, and by 2030 that will be as much as 65%. One of their first priorities is going to be to pay for better healthcare
- Medical breakthroughs are now coming through at an increasingly rapid pace in areas such as cancer, HIV, gene therapy etc. A lot of these advances are helping people with chronic diseases live longer
These are all reasons for the demand for healthcare to keep growing every year over the next decades.
Outperformance because it fares better in the bad times
Since 2000, the MSCI World Health Care Index has had an annualised performance of +7.5%, whereas the regular MSCI World generated +4.7%. That’s an outperformance of +2.8% a year!
Part of the reason for that longer term outperformance is the fact that healthcare is a necessity with no substitutes. Even in recessions people will not cut back on it in any significant way. In 2008 the health care index did have a negative return of -21%, but the broader MSCI World returned -41% over the same period.
Moreover, in the period that followed, healthcare stocks outpaced the broader indices. So the bad times weren’t as bad, and the good times were better.
So to summarise, why should I invest in healthcare?
The three main reasons you should consider to allocate some of your investments into healthcare related stocks are:
- Higher risk-adjusted returns. Healthcare features a historical Sharpe ratio of around 0.47 versus around 0.3 on all global stocks. Simply put, that means you got more units of return per unit of risk
- Smaller losses during drawdowns. MSCI World lost -41% in 2008, whereas MSCI World Global Health Care lost only -21%. In the years after that, healthcare beat the index again.
- Fundamentally there is much, much more to come. The world population is rapidly ageing and becoming increasingly middle class while medical breakthroughs are coming faster than ever
What have been some of the key medical advances of recent years?
As this article and this one outline, some of the biggest advances in the past decade alone have been in the areas of:
- 3D printed body parts
- gene therapy and stem cell research
- cancer therapies
- bionic eyes
- synthetic cells
- a cure for hepatitis C
- minimally invasive surgery
Since 1950, the number of drugs approved for use by the FDA doubled every year and given all of the above should not be slowing down any time soon. All these advances help humanity live longer and better lives, but they also create opportunities for new technologies to carve out niches in the market and drive growth.
Healthcare is a highly diversified industry
The healthcare sector is comprised of everything from hospitals and medical care to pharmaceuticals and biotech, medical devices manufacturers and health insurance companies. Each of those subsectors will have different dynamics and different risks attached to it.
Whereas pharma, biotech and medical devices are the ones to deliver and profit from spending on research and development, the health insurance firms and private hospitals are well positioned to profit from overall demographic trends like ageing populations. On the other hand, these are also the ones most at risk from changing regulations and public anger about increasingly expensive healthcare.
Some of the subsectors within healthcare include:
- Hospitals, nursing and residential care or other care services. Including everything from full-blown hospitals to nursing homes, doctors, chiropractors, homeopaths and psychologists.
- Medical devices. Provide machinery and tools to doctors and hospitals that can be used to diagnose or treat certain conditions
- Pharmaceuticals. spend money on research and development to create drugs on a chemical basis that prevent, alleviate and cure diseases
- Biotechnology. similar to pharmaceuticals except they produce their drugs on a biological rather than chemical basis
Naturally, within R&D of the last three mentioned above, the success rate is highly hit and miss, and finding individual companies that succeed can be an extremely difficult task.
Big pharma firms like Johnson & Johnson diversify that risk by having a balanced product portfolio that besides consumer goods and medical devices features pharmaceutical products across for instance immunology, cardiovascular disease, vaccines, neuroscience, oncology, etc.
Yet in order to find even better diversification, you need to look at ETFs.
Portfolio construction: pharma, devices, innovation and cancer
- I have designed a portfolio that includes a 20% weight to an overall healthcare sector ETF, and splits up the remainder to a cancer immunotherapy specific ETF, a medical devices ETF, a healthcare innovation ETF and a pharmaceuticals ETF
- This gives broad-based exposure to the sector, though with an overweighting to innovation and devices, which though having more of a growth orientation and fairly high average P/E ratios, should help to generate outsized profits as they come up with new products
- This is a high risk portfolio, with a 99% Value at Risk over 1 year (max. expected loss with 99% certainty) of over -21%. Nevertheless, stress scenarios also show that losses in periods like 2008 are in fact not quite as bad as the VaR seems to imply. If you prefer a healthcare portfolio with lower risk, you could opt to lower exposure to HEAL and IHI in favour of IXJ.
- Moreover, a return of +211% since 2010 makes it obvious that over the long run this portfolio should be a sound investment under practically any scenario you can imagine
|Innovation||iShares Healthcare Innovation ETF||HEAL||0.40%||25.0%
|Devices||iShares US Medical Devices ETF||IHI||0.43%||25.0%
|Cancer||Loncar Cancer Immunotherapy||CNCR||0.79%||10.0%
|Healthcare overall||iShares Global Healthcare ETF||IXJ||0.47%||20.0%
|Pharma||SPDR S&P Pharmaceuticals ETF||XPH||0.35%||20.0%
Risk, diversification and allocation
- Risk level: high
- Diversification: low
- For risk and total return since initiation see Portfolios
- Probability of this theme playing out in the next 3-10 years: 50%-100%
Portfolio characteristics (full look-through, from USD perspective)
- Dividend yield: 0.7%
- Ex-ante predicted volatility: 12.8%
- 1 year 95% Value-at-Risk: -21.2%
- Scenario: 2008 Lehman Brothers default period: -19.1%
- Scenario: Interest rates +100bps: +6.3%
- Scenario: 2008-2009: -10.5%
- Scenario: 2010 onwards: +211%