Long-term energizers boost healthcare sector

The healthcare sector rebounded strongly at the end of the year despite a weak start to 2019.

That momentum should carry through in 2020, says Paul MacDonald, Chief Investment Officer at Harvest Portfolio Group. The Oakville, Ontario-based portfolio manager was founded in 2009 and focuses on ETFs with a strategy of conservative growth and income.

In a Q&A, Mr. MacDonald talked about the philosophy behind the Harvest Healthcare Leaders Income ETF, the long term energizers driving healthcare stocks and why he believes the the sector will continue to perform regardless of U.S. election year anxiety.

Q: What do you see for the healthcare sector in 2020 and beyond?

PM: Over the medium to longer term, the healthcare sector has several themes. The first is aging populations. The second is technological innovation in medical devices, equipment and drugs. The third is rising demand in emerging markets. These are permanent and noncyclical forces, so we want to be positioned there.

In the shorter-term, we see attractive valuations, though U.S. political noise will continue this year. But over the past 3 or 4 months there has been a positive shift in the sentiment towards the sector. It has been a noticeable change.

What were the surprises in 2019?

Healthcare was the second worst performing S&P sector behind energy. What drove that? In part the extreme views and rhetoric as the Democratic primaries came into focus early in the year. The talk about socializing the system worried some investors.

You could see that impact when it came to quarterly earnings. The stocks of companies with strong earnings and guidance would struggle to rally. If they missed earnings it was a very painful experience.

But as the year went on there was a shift. Companies were rewarded again for robust earnings. So when I look at 2020, I think you have an environment where valuations are discounted, sentiment is improving and some of that extreme rhetoric has subsided. Policies are coming much closer to centre. When you put that together, we see an incredible longer-term opportunity.

How should investors approach the sector?

If you want healthcare exposure you want to own a basket.

Medtech has been the shining star for several years and on the flip side biotech has underperformed. Large cap biotech companies have been under pressure for the past 12 to 18 months. Even hundred billion dollar market capitalization companies, a momentum shift can move share prices by 30% in a very short span.

Medical technology companies have shown a clear growth picture. So they’ve been afforded much higher multiples. Perhaps this is because they’re perceived to have less exposure to some of the political narrative. That trend could continue.

We want to be in those types of companies as a group. Any individual name, say Johnson & Johnson, a $340 billion company, can move 15% up or down based on whether it’s the news, or there have been disappointing drug trials, political noise or the threat of lawsuits.

So for us, diversity across the subsectors is key, being exposed to all areas including med techs, pharmaceuticals, biopharmaceuticals and managed care such as insurance.

How much will U.S. politics affect things in 2020?

We are likely to have rhetoric all year, but does the market look beyond it? It would seem to me that it is starting to do that.

What we saw in early 2019 is actually what I would’ve expected in early 2020. But as you peel back the layers of the system, you realize it is extraordinarily difficult to effect change.

There are numerous vested parties, whether it’s the manufacturers, distributors, whether it’s the insurance companies. There’s always going to be resistance to radical change.

Tell us about the Harvest Healthcare ETF

We have a very simple process to narrow down the universe of 3,000 companies to about 75. We require a minimum market capitalization of $10 billion. They have to be North American-listed  and have to have options trading so we can take advantage of our covered call strategy. The  covered call strategy generates income by foregoing a little bit of the upside.

From the 75 companies we select 20, filtering for things like earnings, return on equity, cash flow metrics and balance sheet metrics. We look at it as a healthcare pie and want to make sure we have exposure to each one of the pieces: medtech, biotech, services, insurance and make sure we are not overexposed to any one area. We want to be diversified.

About 46% of the holdings are in pharmaceuticals, 18% in biotechnology, 20% in healthcare equipment and supplies and 14% are healthcare providers.

Do you have any final comments?

We are later cycle now.  It is definitely the time to be invested in good quality businesses. That should always be the case, but even more so now.

We think that healthcare is an opportunity for those that can look beyond macro noise. It has defensive characteristics, good dividend yields and valuations that are at discounts to the broader market.

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(This article was commissioned by Harvest Portfolio Group as an advisor education resource.)