Bellevue Digital Health (Lux)

Global markets traded lower in October (-2.9%), as did the US tech sector (Nasdaq 100 -2.0%) and the healthcare sector as a whole (-4.1%). Fast-growing pockets within the healthcare industry represented, for example, by the Russell 2000 Healthcare Index (-9.9%) and the S&P Biotechnology Index (-9.3%) gave up even more ground, as did the Bellevue Digital Health Fund (-15.1%).

Ten-year US Treasury yields extended their upward trend from the previous month and closed October at a multi-year high of 4.93%, up 36 basis points. We think this is the main reason for the negative performance of growth stocks and, by extension, of the Digital Health Fund portfolio. Many investors use discounted cash flows (DCF) to determine the valuation of small and mid-cap stocks and rising bond yields lead to lower valuations in these models.

Of the 39 portfolio companies, Olink (+68.9%), Yidu Tech (+4.3%), Shockwave (+3.6%) and Ping An Healthcare and Technology (+0.2%) made positive contributions to portfolio performance. Thermo Fisher announced the acquisition of Olink, a leading provider of proteomics solutions, in October. It offered Olink shareholders USD 26 per share in cash, a premium of 74% vs the previous close. Shockwave, a company specializing in intravascular lithotripsy for the treatment of cardiovascular diseases, announced new groundbreaking products at its investor day. Shockwave’s sales forecast for 2026 and its addressable market projection, which was almost doubled from USD 8.5 to USD 15 bn, were also positive surprises.

After an interim analysis, Novo Nordisk decided to stop its “FLOW” trial of semaglutide in patients with type 2 diabetes and chronic kidney disease study ahead of schedule because the results were so positive. This news triggered heavy selling in the shares of dialysis companies such as Outset Medical (-67.6%) and even across the broader medical technology sector, for instance in TransMedics (-31.9%), Inspire Medical (-25.8%), Penumbra (-21.0%), Procept BioRobotics (-18.3%), Insulet (-16.9%), Axonics (-8.7%) and Globus Medical (-7.9%). We think the market has overreacted to this news and doubt that the correction will be long-lasting.

Although Dexcom’s (-5.3%) third-quarter sales and earnings beat expectations and management increased its guidance for 2023, the stock was unable to make a positive contribution to the fund’s performance. Intuitive Surgical (-10.8%) also surprised investors by reporting higher-than-expected procedure volumes and an increase in robotic surgery system sales for the third quarter, but it detracted from portfolio performance, too. Axonics also beat consensus estimates for Q3 and raised its guidance for the full year 2023.

Reported sales at Teladoc Health (-11.5%) topped its management’s forecast but not investor expectations. Accolade (-38.9%) likewise reported better-than-expected sales and earnings but it didn’t raise its full-year forecast.

There were also some negative company-specific news flow in October. Outset Medical’s third-quarter sales missed street expectations and management lowered its forecast for 2023, disappointing investors. Align Technology (-39.9%) also fell short of investor expectations for the third quarter, which it blamed on deteriorating consumer sentiment in the US. All performance data is in USD / B shares.

Most of the companies in the fund's portfolio will publish their results for the third quarter in November. Judging by the results reported so far and by our many discussions with executives during the past two months, we expect most of our portfolio companies to present a solid set of quarterly results. Earnings estimates revisions are likely to remain on an upward trend too. In view of the historically low valuations, we would not be surprised if more healthcare and tech giants take advantage of the current market environment and snap up fast-growing digital health companies. Meanwhile the downward pressure on growth stock valuations is likely to ease as soon as a broad market consensus regarding the timing of initial rate cuts by the US central bank in 2024 emerges.

The fund's investment strategy is focused on innovative market leaders and solidly financed companies. More than 95% of the companies in the portfolio have no immediate financing needs. Companies in the highly regulated and non-cyclical healthcare market also benefit from the industry’s high entry barriers. The portfolio contains fast-growing, disruptive companies that are applying digital technology to improve healthcare delivery and outcomes while making healthcare more cost-effective. In addition, the companies in the Digital Health Fund's portfolio are expected to generate high double-digit sales growth rates over the coming years and visibility is good.

The growing acceptance of digital solutions in the wake of the pandemic has pushed up the potential growth trajectory of the digital health investment case. Equity capital investors have invested about USD 109 bn in more than 4 700 privately held digital health firms since 2011, so we expect a steady stream of attractive IPOs in the coming years – another reason, and an important one, for investing in this sector.