What are the megatrends driving healthcare investment opportunities?

Historically, when investors thought of healthcare in the investment world, they would normally go straight to big pharma – the likes of Johnson & Johnson, Pfizer, Roche or GlaxoSmithKline come to mind.

However, the emergence of various megatrends in recent years has created opportunities beyond big pharma (e.g. medtech, biotech, healthcare equipment & services, insurance) that investors can benefit from, across a range of asset classes. 

The two specific megatrends, out of the five key megatrends that we expect to shape the trajectory of the global economy, are demographics and technological advancement.

Demographic trends and changing healthcare needs

Powerful demographic trends are currently in motion. Rapidly ageing populations across the world will have a greater need for healthcare. In Asia and Africa an expanding middle class will demand greater access to healthcare and modern medicine. These trends, alongside increasing living standards and higher disposable incomes, mean that spending on healthcare is likely to increase significantly.

Population estimates by age groups, thousands

Number of people for every single doctor

Source: United Nations, Department of Economic and Social Affairs, Population Division (2019) and World Health Organization, 2014-2019

Technological advancement and the future of healthcare

We are also arguably in the midst of an evolutionary leap in human healthcare. Technology is revolutionising the sector but is overlooked far too often in favour of more exciting technological advances in computers, phones and cars. Within healthcare, there has already been immense innovation with gene therapy, cell therapy, nanotechnology, robotic surgeries, artificial intelligence and bionics in recent years. 

Along with this, there are currently thousands of medicines in development for the prevention and/or treatment of various conditions, including cancers, cardiovascular disorders, immunological disorders, infectious diseases, diabetes as well as neurological and mental health disorders. And, perhaps less excitingly, there are even developments being made with the efficiency of equipment, services and software for research and diagnostic purposes.  

Starting with the pandemic, we’ve seen both Pfizer and Moderna finally benefit from some genetic technology that had long held huge promise but never quite delivered. But now this technology, messenger ribonucleic acid (mRNA), is everywhere, given its use in their Covid-19 vaccines. This technology is a variation on the natural substance that directs protein production in cells throughout the body. The idea is that mRNA can be tweaked so precisely that, when injected into the body, it can manipulate cells into producing various antibodies. With success in vaccines there will be a lot of effort and associated investment opportunities, in order to utilise mRNA against autoimmune diseases.

Another opportunity is the use of AI and machine learning to drive greater precision and diagnostic capabilities within healthcare systems. Using extensive data, scientists have developed AI algorithms to help improve diagnosis rates and accelerate treatment in the US. The algorithms are used to scan through patient data, picking up on patterns of symptoms, leading to quicker recognition of patients who could potentially have rare or dangerous ailments. While the accuracy of the algorithm varies, most are effective, which shows the potential for further development into this area as it can lead to better health outcomes. Additionally, the AI algorithms have a wide range of applications, including improving recruitment for clinical trials.

3D printing and artificial organs are well known concepts. But taking it up a notch is bio-printing, the next emerging technology in this space. While it was initially used to regenerate skin cells for skin grafts to help burn victims, this has slowly given way to even more exciting possibilities. Scientists have been able to create blood vessels, synthetic ovaries and even a pancreas. These artificial organs then grow within the patient’s body to replace the original, faulty organ. The ability to supply artificial organs that are not rejected by the body’s immune system could be revolutionary, saving millions of patients who depend on life-saving transplants every year. In fact, there are already teams working to transfer these principles to 3D-bioprint major organs, which would significantly reduce the burden placed on donor waiting lists, should they prove successful.

CRISPR is the most advanced gene editing technology yet. It works by harnessing the natural mechanisms of the immune systems in the bacterium cells of invading viruses. This is then able to ‘cut out’ infected DNA strands. The cutting of DNA is what has the power to potentially transform the way we treat disease. By modifying genes, some of the biggest threats to our health (like cancer and HIV) could be overcome one day. CRISPR is still, however, a first-generation tool and its full capabilities are not yet understood, but clearly has the potential to be a game changer.

What are the key risks?

Whilst these technological innovations are all very interesting, as with any investment there are risks involved with investing in healthcare, despite its defensive reputation. The three biggest are product failure, political risks and economic risks. 

  1. The process of invention and coming to market, specifically the clinical trials required by the Food and Drug Administration in the US, can be extensive and lengthy — failing more often than not. 
  2. Political and regulatory issues also pose a threat through universal insurance programmes, healthcare reforms and the potential waiver/shortening of patents, all of which can massively impact healthcare profitability. 
  3. From an economic perspective, increasing competition, the availability of substitutes (including generic versions of drugs) and consolidation trends can all also impact profitability.

Accessing the healthcare investment trend

There are a variety of ways to access the trend, depending on investors’ individual risk profiles as well as their liquidity and governance constraints. Private equity is arguably the most attractive. Most company value is now captured pre-initial public offering (IPO) as companies are choosing to remain private for longer because of the availability of capital provided by late-stage private equity funds. 

Moreover, returns are generated through a range of exit strategies, so benefit from a buoyant IPO market and increasing merger and acquisition (M&A) activity in the healthcare sector, particularly with big pharma. Medtech and biotech, in particular, are the most attractive subsectors within private equity, given that the companies in this space tend to have the most commercial potential.

Venture capital, a form of private equity, involves investing in start-up companies where value is largely based on the possession of intellectual property. These companies can provide much greater returns but the investments involve higher cash demands for research & development and, ultimately, a higher risk of failure. Also, these companies are only in the process of beginning clinical trials and/or getting product approval, whereas private equity will involve companies that are further along this path and, generally, a wider range of products.

Public equities represent a more accessible and liquid route to the healthcare sector. While global equities do provide healthcare exposure, they are dominated by big pharma. Specialist healthcare funds, on the other hand, will offer greater exposure to smaller, more innovative and higher growth companies across a range of subsectors that are likely to drive long-term returns, albeit to a lesser extent than in private equity. 

Similar returns to private equity can be generated on the public side through long/short healthcare focused hedge funds, although this will likely involve meaningful leverage and far greater manager skill risk, as opposed to providing a pure exposure to the trend.

Other asset classes that are able to provide healthcare exposure include private debt, property and royalties. Whilst there are specialist healthcare focused funds across these asset classes, they will generally offer no/minimal upside, potential through equity participation. As such, we would encourage investors looking to invest in this trend to focus on equities. 

Responsible investing and ESG within healthcare

Responsible investing (RI) and Environmental, Social and Governance (ESG) should be taken into account when investing in healthcare. From a sector perspective, investing in healthcare is naturally responsible – it fulfils the United Nations Sustainable Development Goal 3 – “to ensure healthy lives and promote wellbeing for all at all ages.” 

Additionally, healthcare companies generally tend to have no adverse effects on the environment and healthcare funds will focus heavily on governance when evaluating companies, particularly in private markets.

There are also ethical issues that investors will need to consider. Whilst things like animal testing may be considered acceptable for medical purposes, there are issues that can arise; e.g. the potential for designer babies (through gene-editing technologies), price gouging and product safety.

Investing in the healthcare sector – key conclusions

Despite the risks and ethical concerns, we still believe that investing in the healthcare sector is attractive and the outlook for the sector looks favourable over the long-term. Combine the increased demand for healthcare with the technological strides that have been made - and will continue to be made - in the sector and you have a great potential source of returns. More importantly, this opportunity is one that should not diminish, given that people are always going to want to live longer and healthier lives. 

"Combine the increased demand for healthcare with the technological strides that have been made - and will continue to be made - in the sector and you have a great potential source of returns."

As such, we believe that investors should consider an allocation to the healthcare sector as it is a good way to capture the long-term trends mentioned above. If you would like to discuss the healthcare sector in relation to your institution’s investments, or would like assistance with defining the allocation, portfolio construction or to select a suitable manager, please get in touch with your usual Barnett Waddingham contact, if you have one. Alternatively, please contact the author below. 

For professional use only. The information contained in this article is provided for informational purposes only, and should not be construed as advice.

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