Health Care: Rx for Growth and Defense
The Capital Asset Pricing Model — used to price risky securities — suggests growth and defensive investments are mutually exclusive because the more an asset can return, the higher its risk must be. But growth itself can provide defensive benefits when a secular growth story occurs regardless of the business cycle.
We believe health care in the US will offer an investment opportunity that may provide both growth and defense for the foreseeable future because of these three factors:
- The secular trend of an aging population.
- The effects of the Affordable Care Act.
- Strong economic “moats,” or competitive advantages, built by health care companies.
Emerging trend to benefit sector
Currently, 14% of Americans are 65 years of age or older — a percentage expected to rise to 25% by 2025.1 Because elders are large consumers of health care, we expect the health care sector to benefit from this secular trend, which is uncorrelated to the business cycle.
Japan has experienced a parallel demographic situation. As Japan’s 65-plus population rose from 1995 to 2011, to nearly a quarter of its population,2 the MSCI Japan Index had a total return of -40.6%, while the Nikkei 225 Index’s total return was -48.1%.3 By contrast, the MSCI Japan Health Care Index returned a total of 99.6%,3 at least in part because of the strong secular trend of an aging population.
Affordable Care Act to increase consumer pool
The primary goal of the Affordable Care Act is to increase the number of people who are insured, consequently increasing the pool of people seeking medical treatment. The Congressional Budget Office projects the number of newly insured people will reach 32 million by 2018. While we realize that the projection may be overstated and that the Affordable Care Act may undergo revision, we still view it as positive for the health care industry.
Health care companies have wide moats
Health care companies, like all companies, derive their strength from building strong economic moats The stronger and wider the moat a company builds, the more sustainable its competitive advantage, allowing growth generation and providing consistent free cash flow. As this breakdown of subsectors shows, health care companies have strong economic moats, due largely to patent law and regulation:
- Pharmaceuticals: 20-year patent protection, extremely high start-up cost, economies of scale
- Biotech: Product differentiation, high start-up cost, patent protection
- Medical devices: high start-up and switching costs, product differentiation, economies of scale
- Medical services: smallest moat; must manage costs and have minimal government exposure to be successful
We believe the health care sector provides a unique opportunity — the potential for consistently strong revenue growth based on factors outside the business cycle, which may offer a defensive investment. If the US mirrors Japan’s experience with an aging population, the potential secular trend could help make health care one of the strongest sectors in the years to come.
1 Source: US Census Bureau and Aging Statistics.gov, as of Oct. 21, 2013
2 Source: Japan Statistical Society as of Oct. 21, 2013
3 Source: Bloomberg L.P. as of Oct. 21, 2013. Total cumulative returns, including dividends, from Jan. 31, 1995, to Dec. 30, 2011.
The MSCI Japan Index measures performance of the large- and mid-cap segments of the Japanese stock market. The MSCI Japan Health Care Index measures performance of the large- and mid-cap segments of the Japanese health care sector. The Nikkei 225 Index (or Nikkei Index) is a price-weighted index measuring the top 225 blue chip companies on the Tokyo Stock Exchange and is commonly considered representative of Japan’s stock market. Past performance cannot guarantee future results. An investment cannot be made directly in an index.
The health care industry is subject to risks relating to government regulation, obsolescence caused by scientific advances and technological innovations.
Investments concentrated in a comparatively narrow segment of the economy may be more volatile than non-concentrated investments.