A True Alternative: Long/Short Allocations to Health Care
- We believe health care is an extraordinary opportunity for alternative investment managers. The global health care sector is large, complex, and, in our view, well positioned in today’s economic and market environment.
- Skilled managers with experience and resources have a range of options to exploit the sector’s inefficiencies and potentially profit from its innovations.
- Despite increased risks, a long/short equity allocation to health care can provide significant portfolio benefits, including alpha potential, diversification, and exposure to long-term growth trends. More than 10,000 Americans on average qualify for Medicare1 every day, and the “graying of the population” is a global trend.
Health care is one of the largest (see Exhibit) and most diverse sectors in the global markets. It includes vast conglomerates of hospitals and caregivers, biotech start-ups, medical device manufacturers, life sciences tools, and networks of pharmaceutical companies. The sector’s public companies are fiercely competitive and profit-driven, but health care is also a vital service. Its customer base includes most of the population, and its position in the global economy is driving rapid scientific and technological advancements.
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The convergence of technology and consumerization is fueling an unprecedented flow of innovation to address unmet medical needs and reduce costs. The sector is already being transformed by millennials, who are unlikely to put up with the bureaucracy, inflexibility, and one-size-fits-all approach that characterized health care interactions before the pandemic. At the same time, we expect technological developments — in everything from record keeping, to wearable sensors, to gene-based treatments — will force companies to adapt.
The acceleration of innovation in the sector will have a lasting impact on the patient experience as the industry switches to more preventive medicine and an outcome-based economic model. This backdrop presents unique opportunities for skilled active managers to generate alpha opportunities — both long and short — across multiple health-care industries:
- Biopharmaceutical companies now have a number of different ways to treat diseases, and the types of technologies being employed are increasing at a rapid rate. As more therapies come to the public market, an investor must consider not only which therapies will be most successful in shaping patient outcomes, but also which will be approved by regulators, reimbursed by insurers, and adopted by physicians and patients. Many tenured managers in the industry have analyzed clinical trials and drug launches over different economic cycles, which helps with pattern recognition to identify which companies may be most (and least) successful, creating significant potential for alpha generation.
- Medical device companies can improve or simplify the surgical process by making it less invasive or more automated. Analysts can assess which devices have more technological advantages and greater adoption by medical professionals. Short opportunities can arise when these companies leverage technologies that will become obsolete or where market expansion or reimbursement will be more difficult than expected.
- Medical tools and diagnostics companies have developed technologies that take the guesswork out of care and make it easier and more convenient for patients to be engaged in their health. These tools can accelerate the research and manufacturing process to further interrogate biologic systems and their interactions. An active long/short approach can capitalize on the technological dynamic by investing in companies with long-term growth potential while shorting those companies that lack exposure to improved technologies when new innovations begin to take share.
- Health care service companies are implementing technologies that can lower the cost of care and improve outcomes, such as initiatives that keep patients out of hospitals or efforts that shift procedures to lower-cost sites of care. By investing in companies that stand to benefit from a move from fee-for-service to fee-for-value models and shorting those companies that fail to reduce cost profiles or improve access to care for patients, an active manager can generate returns on both sides of the portfolio. Selecting the right investments is essential, as this approach can significantly increase the risk of loss.
The sector’s long-term — and short-term — prospects should also be considered. Many investors are aware that health care has solid long-term fundamentals; more than 10,000 Americans qualify for Medicare every day, and the “graying” of the population is a global trend.
However, we also see opportunities in global health care because of once-in-a-generation conditions in the current environment that are making the sector one of the fastest growing areas of the global market.2 Health care services and procedures have been severely curtailed by the COVID-19 pandemic, which has drawn the focus of the industry, prevented one-on-one interactions, and hobbled the agencies responsible for conducting inspections and reviewing drug approvals. As societies and economies around the world reopen, we believe health care will be one of the primary beneficiaries.
Demand for health care services will likely accelerate as patients return to medical offices, more procedures are scheduled, and medical facilities open. While the sector does face challenges — COVID-19 variations remain a threat, a new commissioner was only recently appointed to the FDA, and the political landscape can change over time — the earnings potential should remain high.
The health care sector can also offer the opportunity to generate alpha with low correlations to other sectors as well as to other alternative investment strategies. It’s notable that some areas of health care have been out of market favor for long periods, raising its diversification potential even higher, in our view.
Finally, an alternative investment in health care offers investors potential exposure to true active management skill in a sector that requires both medical and financial expertise, especially in a market where many active managers (and their results) can be scarcely distinguished from their passive counterparts. Long and short positioning gives managers the potential to fully leverage their insights, perspective, and experience on behalf of clients.
Jennison Associates
Jennison's investing approach is rooted in our fundamental research and security selection; all of our portfolios are built from the bottom-up, security by security.
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1“By 2030, All Baby Boomers Will Be Age 65 or Older,” US Census Bureau, December 10, 2019.
2ResearchAndMarkets.com: Healthcare Global Market Opportunities And Strategies To 2022
IMPORTANT INFORMATION
Investing in the health care sector increases vulnerability to economic, political, or regulatory developments affecting this sector. The share price of a health care company can drop dramatically. A short sale creates the risk of a theoretically unlimited loss.
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