The U.S. healthcare sector offers what many investors seek: large companies, consistent demand, and innovative growth tailwinds. The sector contains a diverse array of subsets, each with their own growth drivers in both the shorter and longer terms. They include pharmaceutical companies, biotechnology firms, and managed care providers that provide insurance, and run clinics and hospitals. Combined, the US healthcare sector offers a long history of consistent growth, with a market capitalization multiples greater than the entire TSX.
“We see in the U.S. healthcare sector an attractive set of massive companies, with dominant market shares and innovative business practices,” said Harvest ETFs Chief Investment Officer and Portfolio Manager Paul MacDonald. “We’ve identified three permanent, non-cyclical and consistent growth drivers for these companies: aging in the developed world, economic growth in the developing world, and the steady stream of innovations these companies offer.”
MacDonald manages the Harvest Healthcare Leaders Income ETF (HHL)—the largest US healthcare ETF listed in Canada. He explained that as North American and European populations age, a larger cohort of individuals will require pharmaceutical drugs, medical technologies, surgeries, and managed care. He noted as well that in developing countries like China and India, growth in healthcare spending has outpaced growth in GDP for most of the past 20 years.
The healthcare sector can offer these growth drivers because healthcare is a superior good. Put simply, healthcare is essential to consumers and countries, and they are far less likely to cut their spending on it when a recessionary period hits.
That doesn’t mean the healthcare sector doesn’t face its own headwinds. Despite outpacing market growth for the past 15 years, the healthcare sector is often sensitive to two “Ps”: patents and politics.
When the patent for a particular drug or technology expires after about 20 years, the owner of the patent loses exclusive rights to produce and market that drug or technology. On major drugs and technologies this can have negative short-term impacts. Patents are a somewhat cyclical challenge in the healthcare sector for pharmaceuticals, medtech, and biotech. MacDonald explained that they can be managed relatively well, however, with patent extensions and new innovations.
“Healthcare companies innovate constantly,” MacDonald said. “Taking large-cap pharma as an example, companies like Merck & Co. Inc. have huge R&D pipelines and the capital required to capture value from innovations by smaller companies.”
MacDonald is particularly bullish on two innovation themes that continued in 2023. The first is approval of new diabetes and weight loss drugs could fundamentally change the fight against a range of chronic illnesses and open a market potentially worth upwards of $50 billion by 2030. While many have heard of Ozempic, more late-stage trial results from Eli Lilly & Company with their drug Mounjaro, have seen very strong results with many expecting this to be approved by early 2024 for the treatment of obesity. The second is in medical devices, essential tools like dialysis machines, infusion pumps, or hip replacements that are being updated almost constantly. Many of these companies are also innovating robotic-assisted surgeries which can help clear surgical backlogs and deliver far better patient outcomes.
The other “P” is politics and that’s the factor most likely to impact sentiment around healthcare going into 2024. US politicians on both sides of the political spectrum have used healthcare companies as a political punching bag, making some investors more wary of the sector during election cycles.
MacDonald explained, however, that throughout its history the US healthcare sector has weathered these political storms. Even when policies are passed that appear to alter the system—such as the Affordable Care Act or the drug price provisions in the Inflation Reduction Act—these businesses find a way to innovate and grow. Moreover, following their key role in resolving the COVID-19 pandemic, these companies are viewed more favorably by the general public and have not been subject to the same levels of rhetoric as in past prior to the pandemic.
“The things that make regular investors nervous, like politics and patents, make a seasoned healthcare investor look for opportunity,” said MacDonald.
He explained that the HHL ETF is designed to manage these cyclical changes while capturing the long-term growth drivers in healthcare. It does so by investing in a portfolio of 20 mega-cap healthcare companies, diversified across subsectors and styles. Mega-cap companies typically have the greatest market share and greatest ability to survive and even thrive economic cycles. Diversification offers ballast—when a headwind impacts biotech, pharmaceuticals and managed care might be unaffected. HHL also pays a high annualized income yield generated through dividends and an active covered call strategy.
“By writing covered calls on our holdings actively, we can pay consistent monthly cashflow to unitholders while ensuring as much of the portfolio as possible is exposed to market upside,” MacDonald said. “That income can contribute to total returns through any short-term downturn, while the portfolio’s mega-cap diversified holdings can capture the long-term upside potential we see in healthcare.”