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Fundamentals favour healthcare sector

Perceptions about Big Pharma have changed as they have turned their resources towards a cure for Covid-19.

The healthcare sector has been in the spotlight as Big Pharma turns its financial and scientific resources towards a solution to the Covid-19 pandemic. Their efforts to develop a vaccine have put drug companies in a global spotlight and changed perceptions about them.

Beyond a pandemic vaccine, other positive forces are at work in the sector, during a challenging and unusual year. As lockdowns have eased, pent up demand for delayed treatments has been strong.  Election year rhetoric south of the border has all but disappeared making investors optimistic about the prospects for drug companies.

These trends have helped healthcare stocks rebound from their spring lows and the momentum should continue, says Paul MacDonald, Chief Investment Officer at Harvest Portfolio Group. In a Q&A, Mr. MacDonald talked about healthcare’s long term energizers, the philosophy behind the Harvest Healthcare Leaders Income ETF and how the ETF is benefitting from the trends.

Paul MacDonald is Chief Investment Officer at Harvest Portfolio Group. Credit: Harvest Portfolio Group

Q: Why have healthcare companies done well this year?

PM: Healthcare is what we call a superior good which means we need it in good times and bad. That affords the sector some positive characteristics in recessions.

For example, between February 28 and April 30, broader markets were down, but healthcare was the best performing subsector in the midst of all that. The S&P 500 was down 1.12% between those dates, but healthcare was up 8.35% and has continued to advance higher since then. So it did what one would expect it to do.

What are the sector’s long term energizers?

There are three. The first is aging populations in developed countries which means an increasing demand for drugs and surgical procedures. This, in turn, is driving technological advances in medical devices, equipment and drugs. The third is that emerging markets are maturing which means higher demand for basic services, including healthcare insurance.

These are ongoing and noncyclical forces.

How have our attitudes changed?   

We have seen Big Pharma commit a massive amount of resources towards a solution to Covid-19. That investment has the potential to change our lives for the better and has helped shift the overly negative sentiment towards them.

Vermont Senator Bernie Sanders rattled investors during his run for the Democratic Party nomination. He is a staunch supporter of Canadian-style healthcare. Credit: Bernie Sanders Campaign

Coming into the year, things were different. Bernie Sanders proposal for a medicare for all cast a shadow over the sector. From a Canadian perspective universal healthcare makes sense, but attitudes in the U.S. are different.  Their  system is extraordinarily complex with many vested interests and is resistant to radical change. Joe Biden is more of a centrist on healthcare policy so that eased concerns.

How else has the pandemic affected the sector?

Medical devices were hard hit as elective surgeries were cancelled which has left a lot of pent up demand. If you think about it, as things recover what will you do first, buy a new TV or get your hips done?  I would think hips would be top of the list. So the med techs are seeing activity pick up.

You also like managed care companies.

Managed care is not something that we have in Canada. It’s effectively big U.S. insurance companies focused strictly on healthcare. These are massive companies. UnitedHealthcare Group, which is in our  ETF, has a market cap of US $296 billion. They manage insurance plans, have physicians and pharmacies they work with and offer employee health and wellness plans.

They also administer Medicare and something called Medicare Advantage, which allows you to upgrade your Medicare plan. The growth rate of their earnings per share is in the mid teens. At the same time you’ve got attractive 16 and 17 times for multiples.

So we really like the business. It has a great growth profile.

Another example is Pfizer. It is working on a different vaccine, but it would be in the top three or four .

How does Harvest approach the sector?

We look at healthcare as a pie. About 45% of the holdings are in pharmaceuticals, 20% in biotechnology, 19% in healthcare equipment and supplies and 14% are healthcare providers.

They must have options trading so we can take advantage of our covered call strategy. This  strategy generates income by foregoing a little bit of the upside.

What has been the big surprise this year?

I would have to say animal health. This is an area people are spending money as they return to their vets. One of our holdings Zoetis Inc., which is involved in pet health. It has been the best  performer year-to-date. It has two divisions. One is pets and companion animals and the other is livestock.

They also had a successful product launch of a drug that does fleas, tics and worms in one drug. It has exceeded expectations.

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