Healthcare 'covid-19 bubble' reminiscent of dotcom boom, fund managers warn

A fear of missing out on investing in the firm that develops the first covid-19 vaccine has led pockets of the healthcare sector to trade on "eye-watering [valuations] reminiscent of the TMT bubble," fund managers have warned.

The current health crisis has shone a light on the healthcare and biotechnology sectors, with more than 1,000 clinical trials, including over 100 potential vaccines, having been registered in the space of three months, according to Dr Trevor Polischuk, co-portfolio manager of Worldwide Healthcare Trust.

The Nasdaq-listed share price of Moderna Therapeutics jumped almost two-thirds on news it was the first to reach clinical trials, though it has retraced all those gains since.

Appetite from investors to access the sector had already begun to spike before 2020 as political noise surrounding the November US Presidential election begun to abate.

That was compounded by healthcare's defensive qualities, which offered investors protection during the coronavirus market sell-off.

The MSCI ACWI Health Care sector is up 0.5% year to date, compared with the wider market's 9.4% loss, data from Refinitiv shows. Between 19 February and 23 March, those respective indices were down 26.7% and 33.6%.

Many funds in the Investment Association's equity sectors have upped their weightings to healthcare over the past 12 months. Terry Smith's Fundsmith Equity, for instance, has a quarter of its portfolio in the sector.

The Comgest Growth World fund also has 25% of its assets in healthcare firms. Manager Laure Negiar said some of the fund's "long-time favourite names" such as Eli Lilly and Becton Dickinson "were trading at very attractive valuations" during 2018 and 2019, amid pricing worries.

Similarly, retail investors have caught the healthcare bug, with investment platform interactive investor telling Investment Week it had seen an uptick in purchases of healthcare stocks.

Anglo-French diagnostics firm Novacyt, which has been selling Covid-19 testing kits to consumers in more than 100 countries, went from a little-known AIM-quoted stock to interactive's sixth best-seller in Q1. Its share price surged 655% between late-February and mid-April.

"The healthcare sector is unlikely to return to the niches of investments after the current pandemic but is likely to remain popular for years to come," said fund analyst at interactive investor Teodor Dilov.

Overall, investors have pumped €6.5bn into European healthcare open-ended and exchange-traded funds since Q1 2018, according to Morningstar data. Q1 2020 alone saw €2.4bn of inflows, the second-highest quarterly level seen in the past five years.

In the biotechnology sector, after four successive quarters of net outflows totalling €1.3bn, Q1 2020 saw a reverse, taking in €140.7m. 

Indeed, February, at €114.5m, was the best month for biotech flows since October 2018.

"Companies engaged in the discovery and manufacture of a vaccine for Covid-19 have proved to be some of the biggest winners in Q1," said Morningstar's senior analyst, manager research, passive strategies Kenneth Lamont.

Covid bubble
But this appetite has led many to urge caution and fear a ‘Covid bubble' could begin to emerge in some parts of the sector.

"The dispersion of returns and valuations in response to the Covid-19 crisis is quite stark," explained Daniel Lockyer, senior fund manager at Hawksmoor Fund Managers.

"Companies that specialise in discretionary procedures, such as dental or elective surgeries, have lagged companies who are working hard to develop a viable vaccine.

"Some of the valuations in the drug development sector are eye-watering and reminiscent of the TMT bubble in 1999 as investors fear missing out on the company that develops the vaccine first."

Even in some of the leading, defensive, large-cap names, Negiar has begun to take profits, as "it has become very well-appreciated how resilient some of these companies are and that they might even be beneficiaries of the current environment".

Healthcare and biotechnology sector specialist managers are even more cautious, with International Biotechnology Trust's investment director Ailsa Craig noting vaccines have historically "not been a great place to invest". 

"It has not been a massively successful area in terms of profit," Craig explained.

"I do not think a pharma company is going to come out and price anything that is successful to an extent that they are going to make a lot of money out of it, especially in an election year."

As Lydia Haueter, senior investment manager on the Pictet Biotech fund, pointed out, while the discovery of a vaccine would be a boon for society and gain the companies involved plaudits, investors must assess the situation differently.

They must factor in what the competitive landscape looks like, whether the vaccine provides immunity for life or if periodic "boosters" are needed, while pricing and the size of the market must also be considered before making judgements on whether it is an investible opportunity.

"We do not have any visibility on any of these issues. We are dealing with a lot of uncertainty," said Haueter (pictured right).

Gilead, for instance, is currently giving away its remdesivir product for free, and is only likely to break even once it starts charging consumers.

"There is going to be limited profits generated from this during the pandemic stage," said Polar Capital's co-head of healthcare Gareth Powell.

"Ultimately, if it comes back and proves to be a seasonal thing then I think the companies would look to generate returns on an ongoing basis, but from this crisis I would not see anyone generating significant profits.

"I would just advise caution in terms of what we have seen in some of the Covid-linked stocks. They have gone up a huge amount, but the reality of what comes out of this is going to be very different to some of the hype in some of the stocks."

Craig said IBT has shunned some of the hotter names, while reducing its holding in Gilead in anticipation of retail money flowing in.

"We need to see evidence before we can really back these companies," she said.

Positive trends
However, the outlook for healthcare overall is positive. Headwinds linked to the US election have abated as a result of Joe Biden edging Bernie Sanders out of the Democratic nomination.

"If you had offered me that back in October, I would have bitten your hand off," said Powell.

Should Biden win, he said the worst the sector can expect is a continuation of Obamacare, rather than a single, government-paying system akin to the NHS.

One slight worry for Powell would be a Democratic clean sweep, taking both the House and Senate: "But even if you had a Democratic sweep, the majority would be minimal in the Senate. Investors have been investing in a healthcare environment under Obamacare for the last ten years."

Areas of interest currently include oncology, where Haueter sees "a lot of innovation in the way cancer is treated, with targeted therapies tailored to the mutation profile a specific patient".

Elsewhere, rare diseases, such as gene therapies, are an "untapped area", Haueter continued. "Currently only 5% of all rare diseases have an approved therapy, so there is still so much to do for the industry."

Powell expects to see a significant increase in healthcare infrastructure spending, as the Covid crisis has shone a light on the difficulties in running intensive care units at such tight capacity.

This should benefit medical device companies and others offering products and services in this area.

Telemedicine demand has also grown exponentially through 2020, while Powell thinks the amount patients adhere to medication will jump from the current 60%, "which I think is really important".

Other long-term trends that have paused during this year should recommence once we are closer to normality, according to Polischuk.

These include industry consolidation, which spiked in 2019, and a continued rise in drug approval rates from the US FDA.

Lockyer said Hawksmoor's three funds all have exposure to healthcare through sector specialists, "who have medical and science backgrounds to provide excellent insight and expertise when investing in this broad and complex sector".

The firm's current core allocation is through Bellvue's BB Healthcare Trust, which "acts as a very good one-stop-shop for investors" as well as actively managing its discount close to net asset value.

Its higher-risk mandate owns Polar Capital Biotechnology in the belief "this is where the greatest potential returns, albeit with higher volatility, will come from".

Dilov likes Worldwide Healthcare, which "offers attractive and diversified exposure" to the sector while spreading risk through global exposure and diversification across different sub-sectors.

The analyst also highlights Impact Healthcare REIT, which manages a portfolio of healthcare real estate assets in the UK, including residential care homes.

"It is an adventurous pick, even more so now given the perils experienced by the property sector during the coronavirus lockdown," he said.

"Whatever your views on property right now, it is a major asset class which long term, many investors will not want to ignore."