Health Care Investing: Interview with Sam Isaly of Eaton Vance
In Personal Finance, I continue to recommend several companies in the health care industry.
— Elliott Gue, Personal Finance
The health care industry was mired in uncertainty for much of last year as markets reckoned with President Obama’s Patient Protection and Affordable Care Act. But 2011 tells a different story for this vital sector. Although the S&P 500 has put up a respectable 6.7 percent gain this year, the MSCI World Health Care Index has returned 12.7 percent and the Nasdaq Biotech Index has advanced by 16.6 percent. But health care and biotech are notoriously difficult industries to assess, even for professional investors. We spoke with Sam Isaly, managing partner of OrbiMed Advisors and portfolio team leader for Eaton Vance Worldwide Health Sciences (ETHSX) to learn about opportunities in this challenging sector.
John Bishop: Where does the health care industry stand after the President Obama’s health care reform?
Sam Isaly: We run a worldwide health sciences fund, not just a US-focused fund, so it’s important to understand the global context. Several macroeconomic factors contribute to the sector’s growth worldwide—an aging population, growing wealth and technological advances. Given these factors, health care spending will grow at a faster rate than the global economy.
There are a few critical time periods to keep in mind. Roughly speaking, a broad range of industries reached their stock market peak around Sept. 30, 2000. From that date through March 2010, health care shares worldwide underperformed the market, though they did advance. Part of that underperformance was driven by concerns over the development of health care architecture in the US and whether there would be changes to the health care system.
About 80 percent of Americans currently have health care coverage, and the bill will add an estimated 30 million Americans, which will bring the coverage to about 90 percent. That will have an impact on demand. The legislation that was passed last year expands coverage, but there’s precious little cost control. That’s both good and bad. In the short term, we’re going to have increased demand unaccompanied by price control. But price control is inevitable in the long term. Investors have to be watchful, as the situation could sour in the US.
As a counterpoint, China has no health insurance industry of consequence. But the Chinese political structure has made it a priority to bring better health care to the countryside. We anticipate that there will be highly positive developments in China and even India that should counterbalance negative developments in the US. Health care is very much a worldwide sector.
In regards to changes to the US health care system, we anticipated a relief rally would occur after President Obama signed the new legislation. This rally did not transpire immediately. The health care sector continued to underperform the market from March through the end of 2010. The S&P 500 gained roughly 15 percent last year, while the health care sector gained about 1 percent. However, it became apparent at the start of 2011 that a rally was beginning.
John: What are some of the most exciting developments in the industry?
Sam Isaly: We are on the cusp of realizing the promise of genomics that was first manifested in dreams about two decades ago. It’s taken longer and cost more than predicated for this to become a commercial reality, but now it’s at hand. DNA sequencing has become easy and inexpensive and will revolutionize our lives over the next decade. The price will drop to about $1,000 in a few years, and it will change the world.
For example, cancers are nothing more than genes that stimulate uncontrolled cell growth. If we can identify the mutation, or polymorphism, we can design a therapeutic that specifically addresses the uncontrolled aspect of the gene.
The most dramatic example of this is a drug called Gleevec, sold by Novartis (NYSE: NVS). Gleevec treats BCR-ABL leukemia, which is caused by a disorder of the BCR-ABL gene. Gleevec is one of the first drugs that specifically targets a genetic fault. It’s turned this type of leukemia into a controllable, chronic disorder rather than a rapidly fatal disease. DNA sequencing will do the same for other cancers and disorders.
Sequencing can tell you what disorders you’re most likely to suffer from, and even provide an expected timeframe for y our death. I had my DNA partially sequenced for $500, and the results suggest that I will die in my 90s from a heart attack. I’ve since modified my behavior by taking baby aspirin and Lipitor to reduce my cholesterol.
Illumina (NasdaqGS: ILMN) is the world’s most efficient gene sequencing firm and boasts the biggest market share. The technology is changing rapidly, and Illumnia faces some risk from competition, but the stock was the biggest contributor to our increase in net asset value last year.
There are other applications of this technology. For example, the management of a pregnancy typically involves an amniocentesis. The large needle required for this procedure disturbs the fetus and there’s a small chance that the test itself could cause a miscarriage. It’s now possible to take a quantity of maternal blood and tease out the fetus’ DNA sequence to discover if the child may have a condition such as Downs Syndrome. No more amniocentesis, nothing more than a vial of blood, and a major advance for families. That test, which is still pending approval from the Food and Drug Administration, uses the Illumina DNA sequencer and was developed by one of our holdings Sequenom (NasdaqGM: SQNM).
John: How would you respond to investors who view biotech as too speculative?
Sam Isaly: We concur that there’s volatility in that sector, but we have the skills to separate the wheat from the chaff. If you want to participate in the next new thing you need to move into unproven lands and take risks.
However, our fund’s beta is less than 1, which means that our fund is less risky than the broader market, despite its investments in biotech. One reason for the low beta is a worldwide spread of investment that reduces our exposure to individual countries and individual themes. In addition, we moderate our position sizes for company risk. Novartis is our biggest holding at 6.8 percent of assets. Only 1.9 percent of the portfolio is invested in Illumina and 0.5 percent in Sequenom. Sequenom loses tens of millions of dollars every year, Illumina makes tens of millions and Novartis makes multiple billions.
John: What’s your investment case for Novartis?
Sam Isaly: The firm has a market value of over $100 billion. Big pharma faces a wave of patent expirations, and while Novartis does face a patent cliff, it’s manageable. The company’s research productivity has been remarkably strong; it’s been atypical for a major pharmaceutical firm. The company produces drugs, generics, vaccines, consumer products and truly represents worldwide health care.
Novartis has a new drug for multiple sclerosis (MS) named Gilenya. It’s the first pill for MS and it’s rapidly being adopted around the world. There are currently about 13,000 patients who treat MS will Gilenya, and we expect that figure to grow to 20,000 by the end of the year. Gilenya costs about $40,000 per year, which means an exit rate of close to $1 billion in the first 12 months after the drug’s introduction. This drug is on its way to becoming a multi-billion dollar product.
Novartis didn’t discover this drug; the firm licensed Gilenya from the Japanese company Mitsubishi Tanabe Pharma Corp (Japan: 4508). We’ve devoted 5 percent of our portfolio to Mitsubishi Tanabe, which will receive a big royalty from Novartis. We expect Mitsubishi Tanabe to perform even better than Novartis.
John: You also hold shares of insurers such as WellPoint (NYSE: WPT). What’s the investment case for health insurers?
Sam Isaly: Health insurance companies collect fixed premiums. But the bad economy has reduced the number of physician visits and elective surgeries. This means the cost of health care claims to the insurance industry has also fallen. Fixed premiums and fewer claims lead to soaring profits. Hard times for the world, or hard times for the workers in Detroit actually mean great times for health care insurers.
We made a sector call. We own Aetna (NYSE: AET), Humana (NYSE: HUM), UnitedHealth Group (NYSE: UNH) and WellPoint. About 10 percent of our portfolio is devoted to health insurers and we’re sitting on a year-to-date gain of about 40 percent.
John: What are the risks to investing in the health care sector worldwide?
Sam Isaly: There are political risks. Health insurance schemes worldwide are in deficit. Budgets are being broken in many countries. There may be extreme risk in each individual company. I could list five companies in my portfolio that have extreme stock-specific risk. There is a competitor to Sequenom that we’re worried about. But we know where the company stands and will know before the next guy if that competitor becomes a threat to Sequenom.
There’s no doubt that the health care sector will grow at a faster rate than the global economy. But that doesn’t make it a slam dunk for investors. Health care is a technologically-based sector that’s difficult to understand. An investor can certainly build a sensible health care portfolio on his or her own, but it’s difficult and time consuming. I’ll self-servingly quote the ads on television that say, “don’t try this at home,” and proselytize for the benefits of a specialized health care fund.
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