From a human perspective, healthcare never goes out of style. From an investment perspective, sometimes it does. It might seem to be an evergreen sector, yet it suffers market maladies like other sectors do, which means you get years like 2023. That’s when the S&P 500 Health Care Sector Index eked out a tiny 0.3% gain, falling far behind the S&P 500 and its prodigious 24% rise.

“2023 was one of the worst years for healthcare on a relative basis to the market in over two decades,” says Andy Acker, co-portfolio manager of the Janus Henderson Global Life Sciences Fund.

Healthcare had done better in 2022, suffering less than other sectors when investors moved into the space as a defensive play, going especially into large pharmaceutical names. That helped the sector’s relative performance: The S&P 500 Health Care index lost only 3.6% in 2022 while the S&P 500 plunged 19.4%. In 2023, the fortunes were reversed, as investors rotated out of defensive healthcare names into artificial intelligence-driven tech.

The waning influence of the Covid-19 pandemic has also affected healthcare stocks and their revenues. The sector had seen tens of billions of dollars in sales from products addressing the virus, and the pandemic’s ebb meant a substantial decline in revenue for such products. Pfizer, for example, saw its 2023 sales slump roughly 42% from the year before. Its stock price followed suit, falling 41%. Meanwhile, Moderna’s revenue cratered 64% and its shares slumped 45%.

Federal Reserve maneuvers haven’t helped healthcare either. The central bank’s aggressive interest rate hikes hurt early-stage biotech companies that depend on the capital markets. All these factors created a perfect storm buffeting healthcare.

But Acker claims that these woes have masked the sector’s significant upside potential—particularly the rising number of aging people in the developed world (seniors are the biggest consumers of healthcare), as well as the accelerating innovation of drug therapies, and the accompanying rise in Food and Drug Administration-approved drugs.

The sector isn’t monolithic, though, and its various subsectors will always have their share of grand successes and colossal failures. “Healthcare is the least efficient sector in the entire market in terms of the difference between the winners and losers,” Acker says.

Navigating the vagaries of healthcare in search of the winners is a challenge that motivates Acker and Daniel Lyons, his partner at the Global Life Sciences Fund. “That’s what makes it fun to invest in the healthcare sector,” Acker says.

Balanced Approach
The fund has generated consistently strong performance, reporting average annual returns that place it in the top quartile of Morningstar’s health category during all measurable periods from one to 15 years. During its roughly 25-year run, the fund has cumulatively topped its benchmark, the MSCI World Health Care Index, and beat it in all measurable time frames save for the recent three-year period.

Part of that success stems from the background of Acker, Lyons and the other seven members of the firm’s healthcare team, who each focus on subsets of the sector. Acker notes that all members of the therapeutics team have a science background. Three have Ph.D.’s and one is an M.D.

He and Lyons have been working on the Global Life Sciences Fund since 2000. Acker has been portfolio manager since 2007, and Lyons since early last year.

The fund’s managers have traditionally taken a balanced approach, holding roughly a third of the portfolio in biotech stocks, another third in pharmaceutical stocks and one-third in medtech and healthcare service stocks. And that’s basically where things currently stand. 

“We like having that defensive positioning with companies we think will do well even during an economic slowdown or a recession,” he explains. “These are companies with businesses that are isolated from economic activity, and which have strong cash flow.

“When you get sick you still have to take your medicine, so healthcare is defensive relative to the broader markets,” he continues.

The fund includes a combination of defensive stocks with large-cap pharma or HMOs or medtech companies, along with innovative companies that are mostly small or mid-cap biotech and medtech companies. “These are companies with innovative new products that we believe can change the practice of medicine,” Acker says. “It’s our view the innovators addressing unmet medical needs will do well regardless of the economic environment.”

90/90 Rule
The M.O. of the fund’s research team is to understand both the science and the business behind drug therapies. This is where Acker brings into play what he calls the “90/90 rule.”

“We need to understand how a molecule actually works,” he explains. “The first part of the 90/90 rule is that 90% of drugs in clinical trials won’t make it to market.”

The second part refers to the commercial risk of launching a new therapy. “What Dan and I have found after more than two decades in the healthcare sector is when you have a new product launch the consensus estimates from Wall Street are wrong 90% of the time,” he says.

After incorporating their understanding of a molecule’s potential health benefit and market size, they avoid stocks where analyst estimates appear to be too high and buy stocks when they believe the analysts’ estimates are too low.

That worked out well with Horizon Therapeutics, a company ultimately acquired by Amgen last year for about $28 billion. Several years ago Horizon launched a new therapy called Tepezza for the treatment of thyroid eye disease. This painful autoimmune condition causes inflammation behind a person’s eyeball, forcing the eye to literally bulge out of a patient’s head and interfering with vision. Before Tepezza arrived, the only treatment for the disease was surgery.

Acker says the therapy had more than 80% efficacy, but the company had a conservative estimate about how much the drug would sell, assuming it would see only $30 million to $40 million in sales the first year. Consensus estimates were even lower, at $27 million. “The first-year actual sales were $820 million,” Acker says, about 30 times the consensus. “Janus Henderson became one of the largest shareholders in the company before the launch in late 2019.”

Weight Loss, Profit Gains
One of the most exciting areas in healthcare is a new class of weight-loss drugs called glucagon-like peptide-1 (GLP-1) receptor agonists. Initially focused on the treatment of type 2 diabetes, these drugs have shown weight-loss results of 10% to 20% of a person’s body weight, whereas previous drugs typically produced 5% to 7% losses.

The two leading players in this space are among the largest holdings in the Global Life Sciences Fund portfolio—Eli Lilly and Novo Nordisk.

Acker says the fund has held both stocks for about 10 years on account of their diabetes franchises. He thinks they have significant upside potential with their weight-loss therapies. The two companies combined are at a $40 billion run rate for their GLP-1 products. (A run rate uses current sales to forecast future revenue.)

“That market is growing at about 80% annually as of the fourth quarter. But we’re just barely scratching the surface,” he says. “We think this could be one of the biggest markets we’ve ever seen in the healthcare industry.”

Nonetheless, a UBS research report earlier this year highlighted potential growth constraints—at least in the near term—on GLP-1 therapies. It pointed to limited supplies, as well as restricted access to these drugs because Medicare is prohibited by law from covering obesity drugs, and to date there’s limited access to obesity drugs on employer health plans.

Acker acknowledges that demand for GLP-1 therapies far exceeds supply, but says that both Lilly and Novo are investing heavily to expand their capacity as quickly as they can. “A key point is that it’s very expensive to compete in this market, and that gives them a competitive advantage as they’re investing more in both clinical trials and capacity than every other company put together,” he says. “We think these two companies will be the market leaders in this area at least through the end of the decade.”

Other Drivers
Another subsector of healthcare is biotech. Acker and Lyons say this space is primed for growth after a nearly three-year “nuclear winter” that decimated the performance of its equities. The managers note that enthusiasm for smaller companies in biotech soared in 2020 thanks to the excitement generated by quick vaccine development during Covid. Many early-stage companies with no clinical data received funding, and as they progressed there was a high failure rate. Those stocks went down, and investors abandoned the space.

But biotech’s fortunes rallied last autumn after the Fed announced its intended pivot on rate hikes. And the acquisition activity in the space was rejuvenated by October’s regulatory approval of Amgen’s takeover of Horizon Therapeutics. That deal had previously been blocked unexpectedly by the U.S. Federal Trade Commission, and the delay had put a chill on M&A activity. The net effect is that the S&P Biotechnology Select Industry Index finished the year up 7.6%, and Lyons sees better times ahead.

“It’s game on for biotech M&A, and we saw an acceleration of deals in the fourth quarter and we expect that to continue this year,” he says. 

Within the portfolio he highlights the biotech firm Vertex Pharmaceuticals, which the fund has owned for 15 years. “They have a cystic fibrosis franchise that’s set to do around $11 billion in sales this year,” Lyons says.

He notes that Vertex’s therapies have dramatically increased the survival rate among cystic fibrosis patients so that many of them have “carrier” status, which is where you don’t have recognizable cystic fibrosis anymore. “It’s the closest you can get to a cure for about 90% of patients with the disease,” Lyons says. He adds that the company has protection for its intellectual property into the late 2030s for its products.

Acker and Lyons point to Vertex as representative of the companies they strive to invest in.

“We try to find companies that can change the face of medicine by addressing high unmet medical needs, and that we believe have underappreciated clinical or commercial potential,” Acker says. “We don’t need to be perfect, but if we can be more accurate than the market in identifying products that will achieve clinical and commercial success, that can drive outperformance for our shareholders.”