A Roadmap for Effective Healthcare Investing: Navigating the Minefield
By Pavadi Capital LLC
Dec 15, 2018
Hedge Funds
Dec 15, 2018
| Large, diverse, and growing sector
Healthcare is vital to each and every one of the more than 325 million people in the United States. For investors, this large, diverse, and growing sector provides a fertile landscape across which to invest. Indeed, there will be attractive opportunities to invest in healthcare for the foreseeable future due to:
- Organic growth driven by the aging demographics of the U.S. population, particularly as “Baby Boomers” age into their prime healthcare consumption years.
- The diverse and dynamic set of healthcare sub-sectors, which comprise a significant amount of total U.S. GDP.
- The indispensable nature of healthcare products and services that are less prone to economic cycles.
We interviewed Pavadi Capital, a specialized healthcare fund manager, to provide a unique perspective on healthcare that goes against the grain when looking at the opportunity set within this sector. While healthcare exposure can add value to an investment portfolio, not all healthcare exposure provides investors with the same risk / return profile. For investors seeking to generate desirable returns without taking undesirable risks, one approach worth consideration is investing in a portfolio of profitable, publicly-traded healthcare companies, which can be beneficial for investors in multiple ways.
The Healthcare Investing Environment
Healthcare is currently projected to grow to $5.7 trillion and 20% of GDP by 2026. Stakeholders are vast and include both private and public companies. Currently, there are approximately 800 publicly-traded healthcare companies on the major U.S. exchanges, which account for approximately $5 trillion of aggregate market capitalization. Importantly, investing in publicly-traded healthcare companies historically provided investors with an opportunity to outperform broader market indices, and healthcare’s raison d’etre is ideally suited for the growing number of investors interested in impact investing and social responsibility.
The Investors’ Organizational Framework
Organizational frameworks are important for investors. While healthcare can provide investors with the opportunity to generate investment returns over time, it is critical to understand not all healthcare investments entail the same types or levels of risks, both qualitative and quantitative.
For Example: By Investment Product
For investors seeking exposure to healthcare, there is a $250 billion asset management landscape comprised of mutual funds ($110B / 44%), healthcare specialist private funds ($90B / 36%), and ETFs ($50B / 20%).
For Example: By Segments
Given healthcare’s sheer size and inherent complexity, there are many different ways to organize the sector into smaller, more manageable segments, e.g., by sub-sector, by market capitalization, or based on other differentiating characteristics.
Case Study: Risk and Return Metrics for Biotech Sub-Sector
One way to illustrate this insight is to evaluate different healthcare sub-sector ETFs and compare their risk metrics, which highlights biotech as the sub-sector that is quantifiably riskier across multiple metrics. For an even broader perspective, an analysis of the 100 largest ETFs globally reveals that biotech’s volatility and beta are among the highest (riskiest).
Risk Highlights – “The Minefield”
Despite material differences in risk across healthcare sub-sectors, with biotech being meaningfully and quantifiably riskier across multiple metrics, the majority of healthcare specialist investment funds are in fact concentrated in biotech. In addition to biotech, healthcare specialists also have substantial exposure to unprofitable companies. This significant exposure to unprofitable, often development-stage biotech companies, which tend to have frequent binary events, higher volatility, higher beta, deeper drawdowns, and less liquidity, is a challenge for healthcare investors seeking to generate desirable returns without taking undesirable risks. When investors compare investing in healthcare to navigating a minefield, these aforementioned risks come to mind. A key question for such investors is how to most effectively derive value from investing in the large, diverse, and growing healthcare sector. How can one effectively navigate or avoid the minefield?
