Page 24 - DIY Investor Magazine | Issue 33
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  Investors eyeing the strong growth potential of healthcare and biotechnology should, in our view, be mindful of this graph below, which we believe shows the decreasing prevalence of growth in each of the benchmarks.
This possibly reflects the dominance of mega-cap companies in each index, so growth investors may be better off considering an active manager with the flexibility to invest in small and mid-cap stocks, to deliver strong returns over the long term.
Historically low valuations suggest it is a highly interesting time to consider the sector. Nick Greenwood, manager of MIGO Opportunities (MIGO), echoes this enthusiasm, recently adding exposure in his trust through Biotech Growth Trust for its exposure to the “smallest of the smalls”.
This is a Morningstar-style score of MSCI ACWI Healthcare, MSCI ACWI, and Nasdaq Biotech indices. A score above 200 indicates a ‘growth’ portfolio, between 200 and 100 indicates ‘core’, and less than 100 indicates ‘value’, with the latter two indicating lesser levels of growth and lower valuations.
In our view, the graph shows that passive investors are likely missing out on much of the growth opportunity within these sectors, but also that valuations are now in line with broader markets.
If investors believe the historic growth in excess of wider markets will continue, it could be an opportune juncture to consider a trust in the AIC Healthcare and Biotechnology Sector.
A unique feature of the healthcare sector are legal monopolies in the form of patent protection; the upfront costs of researching and developing a new drug or healthcare tool are huge.
Innovations can significantly improve the lives of many people; there are large societal benefits from promoting investment,
so society’s quid pro quo for successful innovators is a period of patent protection, to allow them to capture a return on their investment.
After the period expires (usually 20 years) other companies can use the technology without a licence fee, which typically results in the same drug (a generic) being widely available at a relatively low cost.
Long patents and the inevitability of the ageing process, give Healthcare and Biotech unique and potentially high return characteristics.
An increasingly prevalent sector dynamic is that as companies become larger, they tend to become less successful at innovation, prompting them buy smaller companies with promising technology, or drugs, to protect their revenue growth.
Large healthcare companies have strong global distribution networks that would take smaller companies many years to build up; with a limited window of patent protection, large companies can capitalise on new products far better than small ones leading to a prominent M&A cycle.
With valuations now relatively low and following something of a hiatus during the COVID-19 lockdowns, it is possible that a new M&A cycle will restart, which should be beneficial to smaller and mid-cap company valuations in the sector.
    DIY Investor Magazine · Apr 2022 24

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