Worldwide Healthcare Trust — Managers optimistic about 2021 prospects

As shown in Exhibit 2 (LHS), over the last decade, healthcare stocks have outperformed the broader market by a considerable margin. There are important drivers for continued growth in the healthcare industry including global demographic trends and high levels of innovation. It has also been relatively immune from the negative effects of the coronavirus pandemic. For large-cap biopharmaceutical companies, there have been minimal supply chain and manufacturing issues, while demand has remained robust. The regulatory environment remains favourable as recent years have seen record numbers of approvals of new molecular entities at the US Food and Drug Administration (FDA), while continued M&A activity should be supportive for the performance of healthcare stocks.

Pharma stocks are the largest subsector of the global healthcare industry. In Exhibit 2 (RHS) we show the absolute and relative forward P/E multiples of the Datastream World Pharma index. It is currently trading on 15.2x (modestly lower than the 15.6x five-year average). However, in relative terms this is a 22.2% discount to the world market, which is considerably more attractive than the 1.3% average premium over the last five years. Given favourable industry fundamentals and relatively attractive valuations, investors may continue to benefit from an allocation to the healthcare sector.

WWH was launched in 1995 and is traded on the Main Market of the London Stock Exchange. The trust is managed by global healthcare specialist investor OrbiMed, which has more than $16bn of assets under management (c $5.5bn in public equities). The firm operates from 11 regional offices and has a team of around 100 investment professionals, of whom 30 hold PhD or MD qualifications and 15 are former CEOs or company founders. WWH’s managers Sven Borho and Trevor Polischuk aim to generate a high level of capital growth from a diversified portfolio of global healthcare stocks, and the trust’s performance is measured against the MSCI World Health Care Index (sterling adjusted). Data from OrbiMed show that from the trust’s inception in 1995 to 31 December 2020, its NAV total return compounded at a rate of +16.0% pa, which is meaningfully ahead of the blended benchmark’s total return of +12.0% pa. (The blended benchmark is the Datastream World Pharma/Biotech TR Index from inception to 30 September 2010, the MSCI World Health Care Gross Index from 30 September 2010 to 31 December 2011, and the MSCI World Health Care Index from 31 December 2011.)

There are a series of investment guidelines and limits in place:

Derivatives are permitted to enhance returns and mitigate risk, currency exposure is unhedged and the managers may gear up to 20% of net assets; at end-December 2020, the trust had net gearing of 3.5%.

Polischuk explains there was a significant drawdown in healthcare stocks in March 2020 due to the onset of the coronavirus, followed by a V-shaped recovery the following month. He notes the managers’ pandemic playbook worked well, which included decreasing the number of names in WWH’s portfolio, improving the quality of the fund and selling the names expected to be disrupted by COVID-19. Polischuk comments that healthcare has a long history of outperforming the broader market; hence, he believes investors benefit by having some exposure to the sector. In recent years ‘an explosion in innovation has been beneficial’, he adds.

The manager comments that the outcome of the US state of Georgia runoff election was a surprise, with the Democrats taking control of the Senate (there was a split result with 50 seats per party, but the vice president had a tie-breaking vote). This means the ‘Goldilocks’ scenario of a democratic president and a split Congress did not happen, although Polischuk describes the outcome as more of a ‘blue trickle’ than a ‘wave’ given the Georgia runoff election was very tight, with President Biden receiving 51% of the popular vote. In addition, Democratic control of the House of Representatives narrowed from a 35- to a 10-seat majority. The manager’s view is that many of the elected Democrats are unlikely to back stringent changes to the healthcare sector, while Biden has higher priorities to focus on including the US economy, dealing with the COVID-19 pandemic (the vaccine rollout programme is under scrutiny), securing additional fiscal stimulus, infrastructure and tax reform. The president is more likely to expand the Obamacare programme rather than overhaul the system and Polischuk suggests that while he expects there will be some form of drug price changes, the moves are unlikely to be draconian. The manager thinks generalist investors may be cautious about the healthcare sector in the short term, given increased uncertainty following the Democrats securing control of the Senate, but he suggests this would mostly affect large-cap pharma and large-cap biotech stocks (where WWH is underweight versus the benchmark). Polischuk believes other healthcare subsectors could benefit such as tools/diagnostics, hospitals, managed care and emerging markets.

Considering the 2021 outlook, the manager says ‘COVID-19 has changed the world and is not going away’. He comments that ‘the global healthcare industry’s response to the pandemic has been an undisputed success’. There are c 4,500 COVID-19 clinical trials, which have been initiated in the last 10 months and more than 350 diagnostic tests have been cleared for use by the FDA, spanning both molecular and serological detection methods. There are around 200 vaccine programmes across the globe; two of which have been approved for use in the US, Pfizer/BioNTech and Moderna. Both products have high efficacy (above 90%), while now there are an increasing number of therapies available for the treatment of COVID-19.

Polischuk says the number-one value driver within healthcare is innovation, noting that the sector is experiencing a ‘golden era’ across multiple disease categories and technologies. There have been record numbers of FDA approvals of new molecular entities in recent years: 46 in 2017, 59 in 2018, 48 in 2019 and 53 in 2020. The manager says the FDA is ‘a conduit, not a bottleneck, for innovation’. He is encouraged by deep therapeutic pipelines within the industry and remains positive on the outlook for emerging markets. Within China, demographic trends are favourable leading to higher consumption of healthcare products and services, there are now western-standard approval processes and relaxed IPO rules (allowing pre-revenue and earnings-stage companies to list their shares), there is an increased level of innovation within the country, while the Chinese government has demonstrated its support for the biotech industry.

Regarding M&A, Polischuk notes that the onset of COVID-19 led to a dip in the number and value of deals, but these reaccelerated in H220. He expects high activity levels to continue in 2021; at the recent annual JP Morgan healthcare conference (held virtually this year), companies reiterated the need for further M&A to boost their growth profiles. The manager remains bullish on the prospects for the global healthcare industry in 2021; he and his team will continue to focus on potential company catalysts, be they clinical, regulatory or financial (product launches, sales and profits), while monitoring the global pandemic and COVID-19 trials.

WWH’s broad mandate means managers Borho and Polischuk are able to participate in all subsectors of the healthcare industry anywhere in the world, aiming to generate long-term capital growth. They are able to draw on the broad resources of OrbiMed’s investment team. The firm has employed a Public Equity Portfolio Review process since 2009; the team meets regularly to discuss WWH’s portfolio structure and individual holdings. Topics include clinical events, which have historically been the largest source of biotech and pharma share price volatility; regulatory events; new drug launches; doctor surveys; key opinion leader consultations and other field research. Company meetings are a very important element of the investment process. Stocks are selected from an investible universe of around 1,000 companies, ranging from early-stage preclinical businesses through to multinational biopharmaceutical firms and WWH’s portfolio is diversified by geography, subsector and market cap. The managers seek companies with underappreciated product pipelines, robust balance sheets, strong management teams and that are trading on reasonable valuations. At end-December 2020, WWH had 89 positions, a considerably larger number than 69 at the end of April 2020 as Borho and Polischuk have identified a number of additional investment opportunities in recent months. Its unlisted exposure was 3.3% at end-December 2020 (0.9% at end-December 2019).

At the end of December 2020, WWH’s top 10 positions made up 34.1% of the fund, which was a lower concentration compared with 38.3% a year earlier; seven names were common to both periods. In terms of sector exposure, over the 12 months to end-December 2020 the largest increases are higher weightings to healthcare providers/services (+3.7pp) and life science tools & services (+2.8pp) and lower weightings in healthcare equipment/supplies (-4.5pp) and pharmaceuticals (-2.6pp), while the biotech weighting was little changed. Looking at the trust’s regional exposures, there are higher weightings in North America (+4.3pp and now more than two-thirds of the portfolio) and emerging markets (+3.3pp) and lower weightings in developed Asia (-5.9pp) and Europe (-1.7pp).

Borho and Polischuk highlight a few of WWH’s top 10 positions. Mirati Therapeutics is a biotechnology firm developing targeted cancer therapies for a number of solid tumours including lung cancer. The managers report that Mirati’s clinical development has progressed rapidly with prominent data disclosures in 2020.

Natera is a diagnostics company, an industry leader in non-invasive prenatal testing (NIPT) and other genetic testing. Its core NIPT business has demonstrated continued strong volume growth and received expanded clinical guidance. In August 2020, the American College of Obstetricians and Gynaecologists issued a new set of guidelines, recommending that prenatal screenings are offered to all pregnant people regardless of age or risk factors.

Horizon Therapeutics is a biopharmaceutical company focusing on rare diseases. It was the trust’s top performance contributor in H121, driven by the strong launch of Tepezza (teprotumumab), which is the only US FDA-approved medicine for the treatment of thyroid eye disease, a rare, debilitating, vision-threatening condition. Last August, Horizon’s management team raised its full-year 2020 sales guidance for Tepezza to >$650m from initial expectations of $30–40m, marking one of the best first-year drug launches in pharmaceutical history.

WWH released its detailed H121 results in November 2020, its NAV and share price total returns of +23.1% and +22.1% respectively were ahead of the benchmark’s +15.3% total return. These numbers were achieved despite a negative currency impact, as sterling appreciated by 4.1% versus the dollar over the period (the majority of WWH’s investments are dollar denominated). All healthcare subsectors contributed positively to absolute returns in H121, but stock selection was the primary driver of outperformance. Overweight exposure to emerging biotech and emerging market stocks added to the trust’s relative performance.

Over the period, WWH generated positive absolute and relative returns in five of the six months. The managers remained disciplined, resisting the urge to join the panic selling during the coronavirus-led market selloff. Instead, they adopted a ‘pandemic playbook’ that included seeking extreme share price dislocations; refocusing on its highest-conviction ideas; reducing the number of holdings; increasing the quality of the portfolio; and selling some companies whose businesses they expected would be materially disrupted by the pandemic. They were also careful not to chase all companies involved in the next potential COVID-19 cures, treatments and vaccines. On a stock-specific basis the largest positive contributors to the trust’s relative returns were Horizon Therapeutics (biopharma), Mirati Therapeutics (biotech) and Natera (diagnostics). The largest detractors from WWH’s relative performance were eHealth (medical insurance broker), Theravance (biopharma) and Biogen (biopharma and biotechnology).

Healthcare investors have enjoyed above-average total returns over the last decade. The MSCI World Health Care Index has generated average total returns of +15.9% pa over the last 10 years, while WWH’s total returns are even higher (NAV +18.7% pa and share price +19.9% pa).

WWH has outperformed its benchmark over all periods shown (with the exception of one month) in both NAV and share price terms (Exhibit 6). The trust’s performance versus the broad UK market over the last one, three, five and 10 years is even more notable, reinforcing Polischuk’s view that investors can benefit from an allocation to the healthcare industry.

Following the coronavirus-led valuation volatility in early 2020, WWH has returned to regularly trading close to NAV. The current 1.4% share price premium to cum-income NAV compares with average premiums of 0.5% and 0.3% and average discounts of 0.9% and 3.3% over the last one, three, five and 10 years, respectively.

WWH’s board implemented a discount-control mechanism in 2004, aiming to ensure a maximum 6% share price discount to ex-income NAV in normal market conditions. It has the authority, renewed annually, to repurchase up to 14.99% and allot up to 10% of issued share capital. In H121, c 5.6m shares were issued, raising £192.8m. Issuance has continued in H221 (Exhibit 1).

On 27 January 2021, the board announced a general meeting will be held on 12 February 2021 to approve additional share issuance. It believes this is in shareholders’ best interests as it will enable the company to maintain its share issuance programme and assist in managing the share price premium to NAV; the size of WWH’s asset base may be increased, potentially spreading its fixed costs over a larger capital base and reducing the ongoing charges ratio. It should also make the trust’s shares more accessible to a wider range of investors, which may lead to increased liquidity in the secondary market.

WWH is a conventional investment trust with one class of share; there are currently 63.2m ordinary shares in issue. It has an overdraft facility with JP Morgan Securities and gearing of up to 20% of NAV is permitted; the managers employ a tactical approach and at end-December 2020, net gearing was 3.5%. After generating very strong absolute and relative total returns in April and May 2020, the managers moved to a 5%+ net cash position in June 2020 before increasing gearing last autumn, in anticipation of higher stock market volatility.

OrbiMed is paid a base management fee of 0.65% of WWH’s NAV and is eligible for a 15% performance fee for outperformance versus the benchmark (on incremental outperformance since launch, if it has been maintained for a 12-month period). Frostrow Capital is WWH’s alternative investment fund manager and is paid a tiered fee: 0.3% of the trust’s market cap up to £150m, 0.2% on £150m to £500m, 0.15% on £500m to £1bn, 0.125% on £1bn to £1.5bn, and 0.075% over £1.5bn, along with a £57,500 pa fixed fee. In H121, WWH’s ongoing charge was 0.9%, which was in line with FY20; there were no performance fees in either period.

WWH pays semi-annual dividends in January and July. So far in FY21, the board has announced an unchanged 6.5p per share first interim dividend (the FY20 total dividend was 25.0p per share). The trust’s revenue return in H121 was £5.6m, which was 13.8% lower than £6.5m in H120, primarily due to a fall in the portfolio’s yield. Based on its current share price, WWH offers a 0.7% dividend yield.

In the selected peer group shown in Exhibit 9, we highlight a number of healthcare funds. There are three pureplay biotech funds, Switzerland-based BB Biotech, Biotech Growth Trust and International Biotechnology Trust, four healthcare funds, BB Healthcare Trust, Switzerland-based HBM Healthcare Investments, Polar Capital Global Healthcare and WWH, along with Syncona, which is an early-stage healthcare investor. WWH’s NAV total returns are below average over all periods shown. On the date shown in the table, the trust was one of three funds trading at a discount to NAV. WWH’s ongoing charge is the lowest in the selected peer group, although a performance fee may be payable. The trust has a modestly higher-than-average level of gearing and its dividend yield is 1.1pp below the mean (the four peers with the highest yields pay dividends out of capital).

WWH’s board has seven directors, six of whom are independent of the manager. The chairman is Sir Martin Smith who joined the board in 2007, before assuming his current role in 2008. Dr David Holbrook was appointed in 2007; Doug McCutcheon in 2012; Sarah Bates in 2013; Humphrey van der Klugt in 2016; Sven Borho in 2018; and Dr Bina Rawal in 2019. Borho is a founder and managing partner of OrbiMed and one of WWH’s lead managers, so is considered a non-independent director.

Holbrook is due to retire at the July 2021 AGM, with Smith standing down at the July 2022 AGM, at which stage McCutcheon will extend his term and assume the role of chairman.