Bellevue Digital Health (Lux)

Stock markets closed sharply lower in April. After trading sideways during the first three weeks of the month, equities were pressured by Fed Chairman Powell’s comments that the US central bank was prepared to raise the federal funds rate more quickly and decisively to battle inflation. The appreciation of the dollar (+5.0% to the euro, +5.3% to the Swiss franc) was the only factor that brought some relief for the fund's investors last month. Growth stocks experienced another wave of heavy selling that led to a significant correction in the US tech sector (Nasdaq 100 -13.3%). The broad healthcare sector (MSCI World Healthcare Net -4.6%) gave up less ground, but there was a considerable divergence between the performance of large cap healthcare stocks (Russell 1000 Healthcare -5.2%) and the high-growth small and mid caps (Russell 2000 Healthcare -18.0%). The Digital Health Fund (-20.4%) was unable to escape the general trend and it slipped even deeper into the red at the end of the month when a few companies in its portfolio released disappointing quarterly earnings announcements.

Of the 44 stocks in the portfolio, only JD Health (+4.9%) and Procept BioRobotics (+1.6%) made a positive contribution to the fund's performance. Only a few companies in the portfolio had released their first-quarter results by the end of April. The good results reported by digital medtech companies Dexcom (-20.1%), Omnicell (-15.7%) and Abiomed (-13.5%) were overshadowed by negative macro factors.

Globus Medical (-10.2%) announced a change in CEO (internal CEO successor) and reported slightly weaker-than-expected first-quarter results but it did not revise its previous guidance for 2022 sales and profits. Early indicators that the capital investment cycle might lose some momentum led Intuitive Surgical (-20.7%) shares lower. At the same time, both of these companies reported that the upturn in treatments/surgical procedures seen in March continued into April. This prompted Intuitive to raise its forecast range for full-year procedure growth in 2022 to 12-16%. Quarterly results from Align (-33.5%) confirmed that consumers plan to tighten their purse strings (incl. China), on top of the problems in the supply chain.

Most of the core positions in the digital health portfolio, for example Insulet (-10.3%), Inspire Medical (-19.8%), Shockwave Medical (-27.1%), Axonics (-17.2%), Tandem Diabetes (-17.0%) and Outset Medical (-23.2%), have yet to publish their first-quarter results, but they are not exposed to capital investment or consumer spending cycles. Meanwhile they stand to benefit greatly as they enter new markets, launch new products, and gain market share at the expense of non-digital rivals, plus treatment/procedure volumes are rebounding now that the Omicron surge is winding down.

The outlooks from Teladoc Health (-53.2%) and Accolade (-68.3%) were disappointing, and these two stocks had a combined negative impact of -2.6% on portfolio performance in April. The two companies met expectations with their reported first-quarter revenues, but they had to cut their revenue growth guidance because of customer uncertainty in the face of the current economic environment (recession angst), which made customers reluctant to sign longer-term agreements. Besides that, many small, unprofitable providers of silo solutions are aggressively fighting for market share (e.g. through higher marketing spend, lower prices), which has made the sales process more complicated and costly. In this market environment, providers like Accolade that offer a high-quality personalized healthcare approach must work harder to win over potential customers and existing customers can still suddenly opt for a simpler solution. In our opinion, there’s no doubt that comprehensive solutions like the ones Teladoc Health offers (whole person care) will win out in the long run. In contrast to Teladoc Health (positive operating results), most of its competitors are still deep in the red and will need a steady infusion of capital to stay afloat. Some companies have based their business models on the highly profitable business of selling (prescribing) regulated substances and seem to view patient consultations primarily as a means to an end. We do not think this is a sustainable strategy, and actually rather risky from a legal standpoint. We also see little value added in the simplified healthcare navigation platforms some companies are offering in Accolade's target market. The rise and fall of Castlight is a good example of this. That said, investors will need more than a little patience during this period of transition until the right business models have been established. After the significant correction in digital health valuations, the potential returns have become much more attractive, and we already observed investors entering the Digital Health sector or adding to existing exposure in February and March. All perfromance data is in USD / B shares).

Our investment strategy focuses on innovative market leaders and well-financed companies. Over 90% of the portfolio companies have no immediate funding needs. 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. We also expect M&A activity to pick up significantly. Strong growth momentum and non-cyclical demand put digital health stocks in an excellent position to deliver a pleasing performance.