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Despite Recent Gains, Opportunities Still Available for Healthcare Stocks

Despite Recent Gains, Opportunities Still Available for Healthcare Stocks

Investing in the healthcare sector requires a high degree of familiarity and expertise.

Having witnessed a run-up in healthcare stocks during the last several years, many investors are asking if there is still any value left within the sector. We believe the answer is yes. Our view is supported, in part, by the basic supply-and-demand relationships that are unfolding within the sector today.

 

Increased Demand and Increased Supply Spell Opportunity

Data released by the U.S. Census Bureau help explain the demand side of the equation, showing that the U.S. population is steadily skewing older. As has been the secular trend propelling the healthcare industry for years, an increasingly older population should translate to increased use of healthcare services, as an older population must manage multiple chronic conditions. One other notable consideration from a demand standpoint is the effect of the Affordable Care Act, which has made healthcare insurance available to millions of new recipients.

Conditions have changed on the supply side as well, and we believe the changes could spell greater opportunity for healthcare investors (and, potentially, patients). Specifically, the regulatory environment is having a positive effect on the introduction of new therapies, defying long-held stereotypes that painted regulators as slow and inefficient or, at worst, indifferent.

The U.S. Food and Drug Administration has played a pivotal role in recent years, being much more attentive and expedient in reviewing drugs that treat grave diseases (cancer treatments, for instance). Often, these therapies have the potential to achieve breakthrough status, and FDA officials are treating them as such. For example, the agency has adopted several expedited review programs that pave the way for faster approvals. Each program has a unique designation, including accelerated approval, breakthrough designation, fast track status, and priority review. FDA officials have justified the programs based on demonstrated need for the drugs, specifying that the accelerated reviews apply exclusively to new therapies "that have been studied for their safety and effectiveness in treating serious or life-threatening illnesses and that provide meaningfully therapeutic benefits to patients over existing treatments."* Because of these pathways, patients in critical need are receiving often-life-saving treatments that they might have been denied as recently as several years ago.

Taken together, the long-term increases in demand for health services and the boost in supply provided by the FDA should provide what we believe to be a constructive environment for new investment opportunities within the healthcare sector. While the opportunity set within healthcare is diverse, and the sector has many disparate pockets that are not easily covered at once, we think our assumptions about supply and demand will guide us well over the longer term.

Mapping Our Way Through the Healthcare Landscape

Investing in the healthcare sector requires a high degree of familiarity and expertise. There are at least eight broad subgroups that could easily employ full-time analysts in their own right: biotechnology; specialty and generic pharmaceuticals; medical devices and equipment; life sciences and diagnostics; managed care; medical devices and technology; healthcare facilities; and a broad healthcare services group. Each subgroup is unique, and its constituents can suffer from a lack of cohesiveness. The realm of facilities alone is very fragmented. It includes:

  • academic hospitals and community hospitals
  • for-profit hospitals and nonprofit hospitals
  • hospitals that employ physicians and hospitals that employ a physicians’ association.

While the macro picture appears positive, part of our challenge is to provide exposure to healthcare companies that carve out an easily understood path in what can be an extraordinarily diverse and sometimes ungainly industry. We believe the most prudent way to accomplish this is by following a disciplined research process. We tend to:

  • Focus on companies whose shares trade at a discount to what we view as their ultimate value.
  • Dissect and analyze a company’s peers, competitors, suppliers, customers, and management staff.
  • Search for potential catalysts that could prompt markets to revalue the stock in the future.

 

Change Comes to a Historically Staid Sector

There are a handful of additional considerations that we think will influence the tenor of healthcare markets in the coming years. Two trends that are already gaining prominence among healthcare providers include:

  • An enhanced focus on costs is in the limelight, as healthcare providers try to optimize the value of their limited resources. This attention to costs will likely be heightened as the industry increasingly shifts from volume-based to value-based care. We believe providers will therefore aspire to a heightened measure of managerial expertise within their practices, seeking the best balance between cost containment and the delivery of quality care.
  • A wave of digital innovation will likely empower healthcare providers to drive efficiencies while delivering care anywhere, anytime. The power of the internet, together with the proliferation of mobile devices, could help streamline the interaction between patient and clinician, as administrative tasks and patient engagement are increasingly digitized. In the end, the benefits of enhanced digital programs (such as those that allow information about a patient’s physiology to be routed to her doctor in real time) will likely allow people throughout the healthcare delivery system to be better informed and better prepared to make objective decisions. For patients dealing with complicated cases that require multiple specialists, this could foster an environment in which all caregivers can coordinate their activities and share information more quickly — and crucially, with less chance of error — than before.

 

 

*Code of Federal Regulations, Accelerated Approval of New Drugs for Serious or Life-Threatening Illnesses, title 21, sec. 314, subpart H.

The views expressed represent the Manager's assessment of the market environment as of June 2015, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and summary prospectuses, which may be obtained by visiting our fund literature page or calling 877 693-3546. Investors should read the prospectus and the summary prospectus carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors. Healthcare companies are subject to extensive government regulation and their profitability can be affected by restrictions on government reimbursement for medical expenses, rising costs of medical products and services, pricing pressure, and malpractice or other litigation.

 

Christopher S. Adams is a Senior Portfolio Manager at Delaware Investments

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