Bellevue Diversified Healthcare (Lux)

The October/November equity market rally faded through December as a combination of higher treasury yields and mixed macro data soured sentiment. Once again central banks were a driver, this time the ECB with a hawkish message. The narrative of higher-for-longer interest rates compounded by some weak economic data pressured markets.

The healthcare sector (MSCI World Healthcare net; -1.2%; fund benchmark) outperformed global markets (MSCI World net; -4.3%) driven by a strong performance from pharma. The Bellevue Diversified Healthcare Fund (B-shares; -1.3%) performed broadly in line with its healthcare index benchmark.

In terms of sub-sector leadership, pharma (0.3%) was the best performing subsectors, with all other subsectors recording a negative absolute performance (medtech -0.3%; biotech
-2.4%; life sciences -2.5%; healthcare services; -3.1%; healthcare tech -13.5%). Given the risk-off sentiment in the market, the negative performance for the typically defensive healthcare services suggested some unwinding of extreme overweight positioning.

For single stocks, we have seen a large dispersion. Amongst fund holdings, positive absolute performances in USD from Akero Therapeutics (17%, takeover candidate), Horizon (13%, M&A confirmed), and Beigene (10%, positive clinical data and China reopening) were of note. Negative absolute performances from Relmada (-53%, 2nd clinical trial failure), Euroapi
(-16%, manufacturing set-back drove guidance cut), and Olympus (-11%, margin pressure) were disappointing.

Healthcare fulfilled its role within investors’ portfolios in 2022, proving to be a defensive option in volatile times. The sector outperformed the MSCI World Index by 13 ppt, led by biotech, healthcare services and pharma.

As we enter 2023 the outlook for the global economy remains challenging. Broadly speaking, demand for healthcare products and services are inelastic and very resilient. People still seek and receive healthcare during difficult economic times. Historically, healthcare outperforms in periods of inflation, hiking interest rates, persistent high interest rates, and during the first half of recessions. While a soft-landing for the US economy cannot be ruled out, we expect the uncertainty in the market to remain well into 2023, suppressing any sector rotation risk.

We see a strong rationale for a positive relative outperformance versus broader equities driven by superior earnings growth, and some further re-rating. While the sector moved from a discount to small P/E premium versus broader equities in 2022, there is potential for a further relative re-rating, as was seen during multiple periods historically when we had high geopolitical/economic risk but low healthcare reform risk.

Blue-chip biopharma have performed well in 2022, and reminds us that a diversified portfolio needs to contain defensive quality and deep-value stocks. We slightly favor biotech over pharma where we like the growing near-term cash flows in the large-caps, and stock-picking optionality in the small and mid caps.

Within medtech, we see the normalization of utilization as a positive driver for 2023. Earnings expectations and P/E multiples for the subsector have come down, and as inflation moderates, margins should stabilize.

We see life science tools as the most difficult subsector to predict given the multiple macro scenarios for 2023. Amongst healthcare subsectors, life science tools have been the most negatively correlated with interest rate expectations. Looking forward, COVID headwinds, destocking, biotech funding slowdown, and exposure to the economic cycle are balanced with positives such as China reopening and consistent pharma and academic R&D.

Overall, in terms of subsector positioning, we hold an overweight position in biotech, and are underweight life sciences tools (broadly neutral on other subsectors).