Health Care and Your Portfolio

More than ay any other time since the Affordable Care Act was under debate a decade ago, health care has dominated headlines. The combination of a pandemic and the race for a vaccine along with the 2020 presidential election has brought news from the sector and national health care policy to the fore.

At Adviser Investments, we are proud to be long-term investors. And that means looking beyond the next quarter or the next election cycle when deciding how to invest. The health care industry accounts for 18% of our economy and its products and services are always in demand. Investors in this sector must be prepared to ride out a few rough patches, but we continue to think that a dedicated allocation to health care stocks is a wise choice over time. Here’s why.

Defense and Offense

The health care sector tends to be recession-resistant. Even when economic conditions are at their toughest, consumers continue spending on health care—if you are sick, you have to visit the doctor. Prescriptions and over-the-counter remedies remain in demand. When times are good and more people are employed (and well-insured), medical services tend to flourish—working people typically make more doctors’ visits and can afford elective procedures they otherwise might skip.

Health care is a broad sector, covering companies with a diverse range of business models. It includes large, stable pharmaceutical companies paying substantial dividends; medical device companies that provide life-sustaining products; service companies such as health maintenance organizations (HMOs) and hospital operators; and small biotech companies with no current earnings but huge growth potential—if they create a successful drug. As providers of essential products that consumers can’t stop using when times are tough, health care firms’ revenues may be rocked—but not derailed—by economic obstacles

Our view: The broad scope of health care companies, combined with the needs these companies fill, means the sector can play both offense and defense in a portfolio.

Demographics

It’s no secret. We’re all getting older. In the U.S., nearly 75 million baby boomers are nearing or in retirement, and it’s been estimated that 10,000 people a day will reach age 65 over the next 20 years. But this isn’t just a U.S. story. In Japan and Europe, populations are growing older too. As we age, we consume more health care services and products.

Our view: As demand increases, supply will strive to keep up, which is good for health care companies’ revenues and profits. Businesses will have an ever-growing incentive to deliver innovative and less invasive procedures and medicines to meet the needs of an aging population.

Globalization

While Americans spend the most per person on health care each year ($10,246 in 2017, according to the World Bank), developed economies with government-run health care systems like the U.K. and Canada also spend considerable amounts ($3,859 and $4,755 in 2017, respectively). In contrast, emerging markets such as China and India spent just $441 and $69, respectively.

That’s expected to change rapidly in the coming decades. According to a 2018 study published in The Lancet, global health care spending is projected to double in the coming decades, from $10 trillion worldwide in 2015 to $20 trillion in 2040. Emerging economies are poised to drive the trend with China’s health care spending projected to rise 360% and India’s 287%. Even such steep increases won’t bring emerging economies up to level with advanced economies, but they should provide a strong source of future growth for the health care sector overall.

Our view: The amount of money people in advanced economies are spending on their own well-being suggests that there is enormous potential for the rest of the world to spend more too. This is particularly true in emerging economies, where the middle class continues to expand. After all, one of the first things consumers prioritize as their wealth grows is better and more health care.

Research and Development

R&D functions as the third growth-driver for the health care sector. Biotechnology and medical device companies can be risky investments in their early phases, but if their drugs work or their products deliver as expected, the payoffs can be enormous. Success will yield greater longevity, which will in turn create greater demand for health care services and products in a profitable feedback loop.

Our view: : Investors benefit by finding the right active management team with a proven track record identifying the most promising innovations.

Going Active

Despite several periods of underperformance since 1991, the health care sector has outpaced the broad market. In dollar terms, $100 invested in the S&P 500 index at the end of 1991 would have grown to $1,618 through December 2020, while a similar investment in the Morningstar U.S. Health Care index would have yielded $1,969. In our analysis, Eddie Yoon, the manager of Fidelity Select Health Care, is one of the best in the industry. Yoon and his actively managed portfolio have benefited from the overall sector’s tailwind, but he’s also made choices that added significant value over the years. Over the same period, $100 invested in Fidelity Select Health Care would have grown to $3,034.

At any given point in time, the health care sector could lag the broad stock market. It’s happened before and will happen again. For example, from March 2009 through February 2011, as President Obama’s Affordable Care Act (ACA) became law and was then challenged in the courts, health care funds lagged the overall stock market, as uncertainty over the legislation’s outcome sent investors fleeing the sector.

When wariness around the ACA diminished, investors returned to the sector and health care stocks outpaced the market. In other words, patient investors were handsomely rewarded for looking beyond the short-term noise created by political and regulatory factors.

That’s a pattern we’ve seen repeated over the decades. The table shows that the sector has tended to trail the stock market in the two years following the passage of major health care legislation. But these shorter periods have been more than offset by the sector’s long-term gains.

Politics has once again cast a shadow over the sector—one that likely will continue to loom as President Biden and his cabinet seek to work with Congress on legislation (easier said than done). If Washington actually does reform the health care industry, there will be winners and losers—just as there were when the ACA was put into law. This should create attractive buying opportunities, both for active managers buying individual stocks and investors like us looking to ride the long-term health care wave.

Our view: One sector cannot outperform all the time, or eventually it would become the market. For patient investors, there will be times when owning health care stocks will be uncomfortable, however, the long-term tailwinds of demographics, globalization and new product development remain extremely favorable and augur well for continuing exposure to the health care sector.

This material is distributed for informational purposes only and is not financial or investment advice. Speak to your financial adviser before taking specific action. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

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