Avoiding the perils and pitfalls for high impact healthcare investment

As long-term, bottom-up investors, we are primarily concerned with the quality and sustainable development contribution of individual companies, rather than seeking exposure to themes or sectors. This gives us the luxury of not needing to invest in any healthcare companies, but the responsibility of ensuring that we have validated the actual sustainable development contribution of each company when we do. 

It also means we are not constrained by GICS sectors or benchmark weights and so can take a broad view of health and wellbeing across the system, and around the world. Rather than seeing a GICS sector dominated by large pharmaceutical companies, we have found medical device companies, diagnostics companies and generic medicine manufacturers, all making real contributions to improving access and reducing costs. Looking broader still, take the example of Unilever.5 One of the core investment drivers for this Consumer Staples classified company is health related, as selling soap and providing hygiene education to more than a billion people is arguably a very significant human health contribution.

The broad view also includes companies like Zebra Technologies, which is classified as Electronic Equipment, Instruments & Components by GICS, but whose technology is widespread in pathology labs (and in hospitals) around the world, as their bar code and logistics technology drives more accurate sample tracking and system efficiencies.

This broad view means we must understand how a company’s business model supports lowering health system costs, expanding access and producing real world health outcomes. It also recognises that prevention is better than cure with many healthcare company business models being reliant on preventive approaches not being adopted. 

Instead, we believe that companies seeking to support large and underserved addressable markets, or disrupt rent-seeking incumbents, are more likely to deliver long-term revenue growth. Underserved markets are often developing markets where affordability and access are critical for underpinning a sustainable business model. Lastly, we believe business models which reduce overall system costs will be more resilient as they are likely to benefit from, rather than be targeted by, regulatory interventions. 

An example of a high impact health outcome in large addressable markets is vision correction, with 4.6bn people globally requiring it and almost 60% not having access.6 Vision correction is also one of the most important interventions which can be made to support quality education, showing the interrelationship of different aspects of human development. 

Swiss-listed Alcon, whose long-term success relies on building trust and access to affordable vision correction interventions, partner with organisations to provide training and equipment to surgeons in emerging markets and have developed portable machines for procedures where there is no water or electricity. In addition to the hundreds of thousands of underserved patients benefiting from these products, more than 6m people have been served by Alcon’s philanthropy programmes from 2009 to 2019.7

In addition to making a contribution to sustainable development, company quality is also essential. For us, quality of franchise, management and financials are considered for every company, and we only invest in companies that offer both quality and sustainability. We don’t view these as competing items to be balanced, rather quality and sustainability are almost always interlinked, particularly in high-impact sectors like healthcare. 

We believe a franchise that depends on boosting prices of patented medications, and consequently limiting access, is inherently weak. We regularly discuss the risks of companies overearning, given the privileged and trusted positions they hold, and recognise the risks that overearning today invites in regulation and competition tomorrow. Traditional considerations, viewed over the long term, such as the proportion of recurring revenues, R&D spend and the sustainability of margins also help us understand the quality of these businesses. 

Diagnostic companies are a good example. These companies make up around 5% of total hospital costs but can influence 60-70% of healthcare decision-making.8 While there is the potential in some healthcare systems to incentivise overuse of diagnostics, the overall value to the health system is significant and extends well beyond detection of disease to include early intervention, better selection of treatments and, in the case of infectious diseases like COVID-19, has been critical in tracing and isolating cases to prevent further spread. These companies also tend to have resilient business models due to recurring revenues from consumables. Companies like DiaSorin, bioMérieux, and Tecan all play leading roles in delivering these benefits.

Integrated Diagnostics operates a chain of diagnostic centres across Egypt, Jordan, Sudan and Nigeria, which provide a range of tests to identify illness and aid medical diagnoses. The company conducted 30.5m tests for 7.5m patients in FY19, for an average price of US$4.57 per test.7 These tests help early diagnosis of a range of illnesses, which is essential to treatment and survival rates in countries which have relatively weak healthcare systems.

Healthcare companies often become most important in times of crisis for individuals or societies. The temptation to exploit this vulnerability has resulted in a series of pricing scandals, infamously including Mylan, the maker of Epipens, increasing prices six-fold in 2008 and deliberately misleading the US government to avoid paying rebates. These actions damaged its reputation and resulted in a US$465m settlement with the US Justice Department.9 

The US opioid crisis and the role of the Sackler family-backed Perdue Pharma is another example where short termism and a failure of stewardship came with tragic consequences, resulting in the company facing criminal charges and billion dollar fines for actions taken to turbocharge sales of OxyContin.10

While a good business model can help, taking the long view requires excellent and ethical management and stewardship, another key factor in our quality assessment. We believe New Zealand-based Fisher and Paykel Healthcare is a world leading manufacturer of ventilators and respiratory devices for hospitals and homes. The demand for their products surged during the COVID-19 pandemic due to undersupply in hospitals. While the company’s costs increased due to supply chain issues and shifting deliveries to air freight, they chose not to raise prices for customers, impacting margins in the short term, but strengthening trusted relationships with customers and accelerating the rollout of their machines. This should benefit both the health system and the company in the long term as most of their revenue comes from consumables. 

Another example is Dr. Lal PathLabs, an Indian pathology provider with partners in 22 countries, which performs more than 100,000 diagnostic tests per day.7 The company’s services offer early detection and intervention for illnesses which otherwise might result in costly hospitalisations. The Chairman has said that their strategy prioritises patient numbers over pricing, driving both access and affordability, while underpinning the growth and market leadership of the company for years to come.7