Drugmakers don’t have to dominate a healthcare portfolio. Equity investors should cast a wide net across the sector to find innovation and growth.
Pharmaceutical companies often grab the limelight in the healthcare sector. From COVID-19 vaccines to Alzheimer’s treatments, groundbreaking pharma products aim to cure the afflictions of humanity and improve quality of life. Investors are often enamored by the promise of a potential blockbuster drug to eradicate an intractable illness—and deliver a healthy flow of profits.
Since big pharma companies rank among the largest healthcare weights, they often dominate sector positions in a global equity portfolio or a stand-alone allocation. Yet focusing too much on pharmaceuticals could limit a portfolio’s potential. Companies that manufacture diagnostics, technology and equipment to address the world’s most pressing medical issues have become increasingly important for progress in the healthcare sector.
Changes to the healthcare benchmark over the last two decades reflect this shift. The weight of pharmaceutical companies in the MSCI World Health Care Index has fallen from 82% in 2000 to 41% today (Display). Other industries have become more prominent, offering equity investors a broader array of opportunities in areas such as life sciences tools and services, technology and equipment.
Diagnostics and Life Sciences Tools and Services—These areas are just as important for medical processes as treatment. Advanced testing and imaging can help medical professionals detect disease at much earlier stages, improving the efficacy of treatment and chances of recovery. And the power of sequencing the human genome will unlock additional potential new drugs and help identify diseases earlier.
When pharmaceutical companies conduct tests on new drugs, they typically outsource clinical trials. Eurofins Scientific, based in Luxembourg, is one of the largest diagnostic companies outside the US, offering an array of services from clinical trials to environmental and food testing. Synnex of Japan sells diagnostic equipment to analyze blood, from simple tests to identify a patient’s blood type to liquid biopsies for cancer and detecting Alzheimer’s disease.
In biotech research and development, innovative drug-development processes in areas such as gene therapy or the mRNA vaccine have historically been very capital intensive. Biotech companies needed many tanks for manufacturing biologic drugs in multiple locations. Sartorius Stedim Biotech of Germany has developed a reusable system for the steel tanks used by biotech firms that saves money during the R&D process and is more environmentally friendly, too.
Technology and Artificial lntelligence (AI)—Compared to other sectors, healthcare has been a laggard in our high-tech society. But things are changing. Companies that can successfully adopt new technology may be able to dramatically change the way care is provided and delivered—and can be found in different parts of the sector.
AI is being introduced in commercial tools by companies, including Veeva Systems of the US and Ireland’s ICON. As AI capabilities improve and become more widely used to diagnose disease, we believe companies that offer software as a service for healthcare will enjoy greater demand. Veeva and M3 of Japan offer a range of software services, from clinical trials to home health monitoring to marketing software for pharmaceutical sales.
Equipment and Supplies—From global drugmakers to your family doctor, the equipment and tools used to deliver healthcare products and services are constantly changing. Innovative equipment used in lifesaving procedures can improve outcomes for patients. Consider Edwards Lifesciences, which manufactures a transcatheter aortic valve replacement (TAVR) that helps solve a major heart ailment with a minimally invasive procedure. The global market for TAVR equipment is poised to grow from $7 billion in 2024 to $10 billion in 2028, according to company reports.
For surgeons, a technological revolution is rapidly unfolding. Today, an increasing number of procedures are using robotic tools that allow surgeons to access hard-to-reach spots inside the body with high-precision, minimally invasive incisions, fewer complications and faster recovery times. Intuitive Surgical of the US manufactures a robotic surgery system that is popular in US operating rooms and is gaining momentum outside the US, with significant growth opportunity in Europe, Japan and China, in our view.
Three Attributes Define Healthy Growth
While each industry has different dynamics, we believe investors should look for three attributes to identify attractive healthcare businesses across the sector (Display).
First, look for products and services that improve healthcare outcomes for patients. Second, companies that can help cash-strapped healthcare systems save costs are likely to benefit from strong demand drivers. Third, products that improve outcomes and save costs must generate a profit for the business.
In our view, companies that possess these three attributes are operating in a virtuous ecosystem. The dynamics of a healthy ecosystem provide a foundation for companies to profitably reinvest cash flows, which helps support consistent earnings growth over time. We believe equity investors should always stay focused on business fundamentals when choosing healthcare stocks, rather than trying to predict scientific success, which is extremely hard to do.
To be sure, pharmaceutical companies that meet the criteria of a healthy ecosystem should be included in a diversified allocation of healthcare stocks. But instead of having drugmakers anchor a healthcare portfolio, the starting point should be to search for high-quality business models—wherever they may be found across the evolving spectrum of medical products and services.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.
References to specific securities discussed are not to be considered recommendations by AllianceBernstein L.P.
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