Like every other corner of the economy, healthcare was not immune to the wild market swings in 2020, a year that effectively experienced an entire economic cycle compressed into two quarters. While healthcare is traditionally viewed as a safe haven, with growth found in biotech and pharma, the space doesn’t always lend itself to value strategies. 2020, however, was unlike any other year, and as a value investor, we are seeing compelling opportunities that may not traditionally present themselves under normal market conditions.
One question on the minds of most investors in the healthcare space is the extent to which the monumental effort to develop a COVID vaccine could provide a tail wind. During the first quarter, amid the broader market volatility, the performance across healthcare was very narrow, as pharma, biotech and drug distributor stocks outperformed, while most other segments were pressured by the uncertainty. ETF flows during this time also suggested investors were betting that the COVID antidote would come from the biopharma space. As the year progressed, market breadth improved and bullish sentiment started to lift stocks that could have a role in researching and manufacturing a prospective vaccine.
Fast forward three to four months, ironically, and the pharma names that accepted government funding in developing the vaccine aren’t necessarily positioned to generate a resulting earnings windfall, as federal funding was premised on set prices.
The other major development on the radar of healthcare investors, of course, was the election. A worst-case scenario, from the perspective of healthcare investors, was a Medicare-for-all plan that would have created a major disruption across the entire sector. President-elect Joe Biden’s emergence in the primary election, however, helped to moderate those fears. His subsequent win in the general election, and the potential for a Republican-led Senate, also cheered healthcare investors who like the stability of checks and balances.
So given the evolving backdrop, several areas across the broader sector should prove to be appealing in 2021. Healthcare service stocks, for instance, are showing a good combination of business momentum, strong fundamentals and healthy balance sheets, and certain names within managed care, pharmacy and pharmaceutical research segments are particularly attractive. Those who stand to benefit from the vaccine rollout include those within the supply chain and distribution, including some transportation names outside of the healthcare sector, but we still don’t view the vaccine as a “thesis changing” event. Device stocks, meanwhile, have become expensive more recently, as investors piled back into the segment after elective procedures nearly fully recovered in the third quarter following the initial COVID lockdowns, which created attractive entry points earlier in the year.
Over the past three to four years, the pace of healthcare spending growth has been decelerating, although healthcare still accounts for approximately 18% of the U.S. GDP. It’s likely that certain trends triggered by the pandemic could endure. Telehealth, for instance, which has risen significantly in some cases, but not across the board, has seen adoption rates surge to nearly a third of all primary care visits, up from the single digits prior to COVID. It’s a theme, however, that fits into the prevailing focus of investors on innovation, outcomes and lower costs, which will continue to shape value strategies in the sector.
In that sense, the prevailing investment thesis in healthcare remains unchanged: The winners will be those who innovate, drive better patient outcomes and lower costs across the entire system. Given all of the new variables, however, the approach to find value in the sector has indeed changed.
At Boston Partners, we are applying a barbell approach to target, on one side, high-quality, “compounding” names whose long-term prospects remain attractive but also experienced price compression amid the market swings. Attractive entry prices created opportunities within medical devices, life sciences, contract research organizations and even hospitals. On the other side, there were opportunities to add to names that were unfairly punished, particularly in healthcare technology and dental equipment. Both sides of the barbell, though, are characterized by good businesses with earnings momentum trading reasonable valuations.
Andy Hatem is a healthcare equities analyst at Boston Partners.