Generating Healthy Returns

The SRI Team at Henderson Global Investors sees health-care as a sustainability challenge. We have a holistic approach to sustainability which encompasses both environmental and social concerns. People are living longer and the population is set to grow for a few more decades before shrinking due to declining birth rates. The World Health Organisation states that: “the enjoyment of the highest attainable standard of health is one of the fundamental rights of every human being”² But what is attainable? How achievable is this and who will pay for it? Is investing in health still a good place to grow your wealth?

Growth drivers

Firstly let’s refresh. There is ever growing demand for healthcare, whether from simple demographics, the rise in living standards of vast numbers of people in emerging markets, or due to unhealthy lifestyles of people in the West leading to increased obesity and associated illnesses including diabetes, back problems and heart conditions. None of these drivers are going away any time soon, but who will pay the cost?

Who pays?

Over the last 20 years, healthcare spend has risen at 2-3x the pace of GDP, resulting in the ratio of healthcare spend to GDP rising in the EU from 6% to 11% and in the US from 9% to 17%. This level of growth cannot continue for the next 20 years – government debt-holders will see to that. Total EU, US and Japanese government debt to GDP is still rising in spite of austerity measures implemented to date and now GDP forecasts are falling too. So where next for healthcare spending? Cutbacks are unavoidable from heavily indebted governments which are the biggest payers for healthcare and for whom health is typically their second largest expense. This means that an investor in the sector will need to be selective as to what companies to invest in. Big pharmaceutical companies with large absolute profits and decent margins could form a nice target for cash-strapped politicians. The margins of orthopaedic companies look at risk too. The Greek plan for cost reduction includes a specific target to reduce profit margins on pharmaceuticals from 35% to 15% starting in January 2012³. This may be an extreme reaction, but politicians in other countries will watch with interest and be tempted to follow suit. Pharmaceuticals may also provide long term cost savings – especially where used instead of hospital treatment. The real opportunity for cost cutting is in the inefficient delivery of services – hospitals and staff, which are poorly run, badly configured and inefficient.

One should not forget that there is an economic payback for improved health. There are the obvious direct medical costs, but also indirect costs including loss of productivity. For example, the total cost of back pain has been estimated at 1-2% GDP in the UK⁴. Governments and other payers are likely to focus more than ever on the cost benefits of healthcare and on preventative measures to reduce the overall health burden on the economy. No doubt living longer has its downside – we will all be working longer, but this should help us to retain our health for longer too.

Innovation areas

Whilst I do not expect medical technology to be able to double our life spans again, I do think that tomorrow’s medicine will be far more effective and efficient than today’s. We are still learning about the human genome and so called companion diagnostics which will check your genes to see if a drug will work on you have only recently started to be commercialised. Ultimately there is the prospect of personalised medicine, customised for your genetic makeup and history and even genetic engineering therapies. Then there are stem cells which look likely to be able to provide effective cures for some major disease areas. We are still in the process of digitising healthcare and future generations will have access to medical records and reminders to take medicines or go for checkups on their mobile phones which will also provide extensive diagnostic information and request confirmation that the medicine has been taken. Some of these areas of innovation are closer to reality than others, but all of them will save costs in the healthcare system and represent investment opportunities today.

Investment opportunities

There are clearly some pitfalls for healthcare investors and one needs to be highly selective in stock picking to generate healthy returns. Within the Industries of the Future Fund we look closely at the cost of a treatment or other application and we particularly like to invest in companies that have a clear cost saving proposition for the healthcare industry. IT is one area where there is scope for cost saving applications. We invest in HMS Holdings which recovers over $1bn in savings for its clients in assessing who should pay for a claim. Another example would be Nuance Communications whose speech recognition technology is widely used by doctors in hospitals thus saving the costs of mistakes arising from the notorious handwriting problems that doctors have.

There are innovative treatments in some areas. One example would be NxStage medical which has a portable home haemodialysis system. The current standard of care is three visits to a clinic per week with associated nursing care costs and travel costs, not to mention lifestyle impact. With NxStage, a patient can run dialysis 6-7x a week at night, still go to work and significantly reduce costs to the healthcare system.

A different example would be Healthways which provides disease management services to physicians, health plans and hospitals. They will contact patients to ensure they have taken medicines or done a test or to encourage healthy lifestyles. Such services have been shown to reduce hospital readmissions by over 20% and cut claims costs by 37% over a three year period⁵. As payers focus on ways to reduce costs we expect increased demand for the kind of services that Healthways offers.

Conclusion

There are healthy returns to be had from investing in healthcare for those who are carefully selective in their stock picking and focus on innovative areas which generate cost savings for the system. Companies like these are helping to solve the challenge of the healthcare cost burden and will be able to grow earnings even as healthcare spending declines.