Following the announcement earlier today that it has terminated its placing programme (click here to read more), Worldwide Healthcare (WWH) has now announced its annual results for the year ended 31 March 2022. These show that, following the previous year’s strong returns, both on an absolute and on a relative basis, the year under review has proved to be a challenging one for the trust. WWH’s net asset value per share total return was -5.8% (2021:+30.0%) and its share price total return was -10.8% (2021: +27.4%), both drastically underperforming its benchmark, the MSCI World Health Care Index measured on a net total return, sterling adjusted basis, which rose by 20.4% during the year (2021: rose by 16.0%). The difference between WWH’s NAV and share price performance reflects a widening of its discount to NAV from 0.2% at the start of the financial year to 5.5% at 31 March 2022. The majority of WWH’s assets are US dollar denominated and WWH’s NAV performance was helped by the weakness of sterling over the year, particularly against the dollar, where it depreciated by 4.6%.
The negative absolute return over the year to 31 March 2022 reflected a mildly positive first half, where the net asset value per share total return was +0.4% (2021:+23.1%) compared to a rise in the benchmark of 13.0% (2021: a rise of 15.3%) and a weaker second half where the net asset value total return was -6.2% (2021-5.6%) compared to a rise in the benchmark of 7.4% (2021: 0.7%).
During the year, WWH’s manager continued to pursue a strategy of being underweight large pharmaceutical companies and overweight in both emerging markets and emerging biotechnology companies. This approach had served WWH well during the previous year, but was the principal reason for its relative underperformance during the last financial year.
WWH’s chairman, Sir Martin Smith, says that, while the healthcare sector as a whole performed well during the year, macro considerations rather than company fundamentals were deemed to be most important by investors. In addition, the “growth-to-value” rotation which has tended to favour well-established companies despite their less-exciting growth prospects also showed that investors have been less willing to take on investment risk more generally. This risk aversion has hurt those sectors where WWH has been strategically overweight, including emerging biotechnology, China healthcare, and innovative tools.
He says that risk aversion has also resulted in further pressure on performance as the value of the smaller capitalisation stocks that WWH owns has lagged, while large capitalisation pharmaceutical stocks have outperformed the rest of the healthcare sector, particularly during the last quarter of the financial year. Sir Martin says that this extraordinary fall in the valuation of the biotechnology and other sectors reflects a change in investor sentiment rather than any significant deterioration in the performance of the underlying companies and so he remains confident that these stocks will recover in due course. Leverage levels varied over the course of the year, with the net effect of a detraction of 1.0% from WWH’s performance.
“Looking at performance by sub-sector provides an understanding of overall performance during the year. First, four areas which contributed a significant absolute positive contribution were Pharmaceuticals (benefitting from a macro defensive rotation), Medical Devices/ Technology (a result of stock picking), Healthcare Services (reflecting our sector positioning), and India.
“Healthcare (again, as a result of stock picking). Second, four sub-sectors that contributed a notable relative positive contribution over the benchmark were Specialty Pharmaceuticals, Medical Devices/Technology, India Healthcare (all reflecting the results of stock-picking) and Japan Pharmaceuticals (reflecting our sector positioning).
“However, detractors from performance overwhelmed the positive contributions. The following three sub-sectors were notable in terms of both relative and absolute negative contribution – emerging biotechnology (reflecting macro sector rotation), China healthcare (a result of fundamental investor concerns), and small/mid-capitalisation life science tools/diagnostics (reflecting our overweight sector positioning). Each of these sub-sectors experienced significant drawdowns during the year creating a headwind to the Company’s performance that became insurmountable during the reported 12-month period.
“The largest detractor by sub-sector was emerging biotechnology stocks, which generated over 11% of negative contribution (both in absolute and relative terms). A “perfect storm” of macro factors led to this disappointing performance. The financial year began with a rotation by investors from growth to value stocks, as generalist investors repositioned portfolios to gain exposure to economically sensitive sectors that would benefit most from a post-COVID reopening of the economy. Biotechnology underperformed during this period, as did many other growth sectors to which investors had allocated capital during the COVID pandemic. Many of the shorter-term investors who did not regularly invest in the biotechnology sector, but who were temporarily attracted to the industry’s defensive nature and COVID-related research, appeared to exit the sector.
“In the second half of the financial year, increasing concerns about the U.S. Federal Reserve’s plans to raise interest rates to combat inflation led to continued weakness in technology stocks, especially those earlier-stage enterprises which are not expected to realise earnings for many years. This trend was especially damaging to small capitalisation biotechnology performance and those stocks sold off even further. Overall, these macroeconomic and related factors created the longest and largest drawdown in biotechnology history, with the gap between the S&P Biotechnology ETF (XBI) compared to the S&P 500 Index reaching over 65% during the financial year.
“Adding pressure to the Company’s performance was a significant drawdown in the Chinese markets, including Hong Kong, in the second half of the financial year. The sell-off was precipitated by regulatory tightening by the Chinese government across a variety of sectors, including the internet (and related technology industries) and the for-profit education industry. Even though there were no new significant regulations targeting Chinese healthcare companies, investor fears were materially heightened that healthcare may be the government’s next target. This broad market downturn in China that began in June 2021 adversely and indiscriminately impacted many of our China healthcare positions. Unfortunately, these macro pressures persisted through to the end of the financial year, generating nearly 4% of negative absolute and relative contribution in the reported period. Importantly, we continue to believe fundamental innovation in the China healthcare sector remains strong.
“The life science tools sector was also challenging for the Company in the year under review. Mirroring the broader market, large capitalisation diversified companies significantly outperformed those with a small and mid-capitalisation innovative growth profile, and our positioning in this regard was suboptimal, resulting in over 5% of negative contribution relative to the benchmark. Additionally, there were fundamental factors that drove this large capitalisation outperformance – chief among which was the continued durability of COVID-related revenues as well as a normalisation of non-COVID “base business” performance which led to positive earnings revisions throughout the 2021 calendar year. Our view that the durability of COVID related earnings would come into question amid record high valuations was clearly too early. Whilst we did have modest exposure to Thermo Fisher Scientific and Danaher Corporation, two companies which benefited from these dynamics and offer best-in-class execution, we had lower exposure than our benchmark which damaged our relative performance.
“Separately, our preferred small and mid-capitalisation companies in the innovative tools space weighed on our performance. Whilst we have a positive structural outlook on liquid biopsy and the continued proliferation of clinically successful oncology diagnostics, the sector fell out of favour against the backdrop of demanding valuations and fundamental results that were strong but were insufficient to drive shares higher against lofty near-term expectations.
“Finally, a word on the performance of large capitalisation pharmaceutical stocks in the financial year. As articulated already in this report, pharmaceutical stocks traded mostly in-line with the benchmark throughout the period.
“However, as we approached the turn of the calendar year, this performance began to diverge materially as inflation, interest rates, and geopolitical risks all rose and investors turned defensive. As a result, large capitalisation pharmaceutical stocks moved much higher heading into the financial year end, many of which ended on 52-week highs on 31 March 2022. This created the single largest source of absolute contribution for the Company at over 7%. However, as is our historical norm, we were materially underweight in the pharmaceutical sector in the period, thus creating over 5.0% of negative relative contribution to the benchmark due to our positioning.”
“There were a number of factors that underlay the key positive contributors to absolute performance. These included the beneficiaries of the macro factors described above, such as the outperformance of large capitalisation stocks, alongside a mix of positive fundamentals that also influenced share price moves. OrbiMed prides itself on its expertise within clinical medicine and how that capability helps shape good stock picking within the healthcare sector.
“A prototypical example of this combination of macro tailwinds and good stock picking was AbbVie. Over the past two years, the company has been in the midst of a transformation. Facing the largest patent expiration in industry history –Humira, with peak global sales of U.S.$20 billion – the company has re-invented its immunology franchise with newer, better, and safer drugs in Skyrizi (injectable risankizumab) and Rinvoq (oral upadacitinib), two drugs approved to treat a variety of immunological disorders.
“Investor optimism hit a nadir in September 2021 when the U.S. Food and Drug Administration (FDA) communicated their general concern over the safety of all oral JAK inhibitors (Janus Kinase inhibitors, the class of medicines included Rinvoq), certainly delaying and perhaps denying future additional approvals for Rinvoq, largely considered the “best-in-class” JAK inhibitor in the world. With the stock on the low after falling further on the news, we added meaningfully to our position. That risk paid off two-fold. First, despite a modest delay, the FDA did ultimately approve Rinvoq for Psoriatic Arthritis, Ulcerative Colitis, and Atopic Dermatitis (in addition to the already approved Rheumatoid Arthritis), pushing the stock higher. Second, the stock certainly caught the macro trend towards the start of 2022 when large capitalisation pharmaceutical stocks moved higher in the face of rising interest rates, record inflation, and war in Europe.
“Another pharmaceutical company that has re-invented itself is AstraZeneca. After nearly a decade of declining revenues and earnings, the company has turned itself around under the guidance of CEO Pascal Soriot, creating one the largest and fastest growing global, multinational pharmaceutical companies in the world. With leadership in oncology, cardiovascular, respiratory, and more recently, rare diseases, the company is poised for sustainable, long-term growth. However, these successes have not been without some angst, as a messy but well-intended effort to develop a COVID vaccine created some share price volatility as did the close of the acquisition of Alexion Pharmaceuticals, which sparked investor fears that the company’s stand-alone financials were going to disappoint.
“However, after a robust fourth quarter report, better than expected guidance for 2022, and a strong launch for the company’s COVID-19 prophylaxis injection, Evusheld (tixagevimab co-packaged with cilgavima), AstraZeneca’s share price closed at an all-time high at the end of the Company’s financial year.
“UnitedHealth Group is the largest health insurer in the United States as well as one of the largest healthcare services providers through its subsidiary, Optum. This stock represents another example of a mix of positive fundamentals and a macroeconomic environment that took the share price to new highs in 2022. Heading into its third quarter 2021 earnings, investors faced significant fears of whether increasing medical costs and lingering COVID-related costs (testing, treatment, vaccines) would impede the insurers’ ability to grow earnings. Additionally, regulatory noise became louder with prospects of Medicare Advantage, an insurer-run government programme, would face reimbursement cuts or other challenges to pay for other priorities in a large U.S. federal spending bill.
“However, the company produced strong third and fourth quarter results, along with better-than-expected earnings guidance for 2022. Meanwhile, political negotiations over a large spending bill broke down in the U.S., removing another critical source of risk. Finally, the shifting macroeconomic landscape, including higher interest rates, rising inflation, and a shift out of growth stocks into value stocks, all benefited UnitedHealth, which has since become a “safe haven” in healthcare.
“Shanghai Bio-heart Biological Technology is a cardiovascular medical device startup in China. The company sells two product lines: Renal Denervation (RDN) and Bioresorbable Vascular Scaffold System (BVS). Together, these technologies address the unmet medical needs of Chinese patients for the treatment of coronary and peripheral artery diseases and uncontrolled hypertension.
“Bio-heart’s line of RDN products is a “best-in-class” product in China, with a unique catheter design which is the only one that can be inserted by both radial artery and femoral artery (unlike the competition). The company’s RDN business is also backed by Terumo, the Japan-based global leader in medical technology, in a technology-validating deal. The investment into Bio-heart was an unquoted investment. The company listed on the Hong Kong Exchange in December 2021 and the share price more than doubled during the remainder of the Company’s financial year.
“Before the turn of the decade, Bristol-Myers Squibb became one of the most, if not the most, dominant cancer companies in the world. With pioneering work in revolutionary field of immuno-oncology in the mid-2010s and the U.S.$74 billion acquisition of Celgene in 2019, the company possessed leadership in both the solid tumour and liquid tumour fields of oncology. However, the company has also become misunderstood. Investor anxiety over the company’s growth strategy and increased concerns over imminent patent expirations for key products saw the company’s valuation collapse to an all-time low, with the shares trading with a price-to-earnings ratio of 7.0x during the reported period.
“However, an analyst meeting hosted by company management in November 2021 in New York City proved to be a seminal moment in the company’s recent history. Using that platform, the company provided a deep dive on their pipeline, discussed growth opportunities, and provided long term growth targets. That event, combined with the defensive rotation into pharmaceuticals at the Company’s financial year-end, was a boon to investor interest and the stock re-rated over 30% (in local currency) over the last four months of the reported period.”
“Mirati Therapeutics is an emerging biotechnology company focused on the development of therapeutics for the treatment of cancer. The company’s main pipeline asset, adagrasib, is highly selective and potent oral small molecule inhibitor of KRAS G12C (a mutation that underlies the formation of a number of tumours) that is being developed for various cancers, including lung, colon, and other solid tumours. Despite achieving many development milestones for adagrasib in the year, including a successful new drug application with the FDA, the share price was punished, perhaps unduly, for a variety of reasons, including a stock offering and multiple management changes. Most recently, the stock was under pressure again after the FDA accepted the filing for adagrasib but granted a regular review rather than the expected priority review, pushing the potential approval and launch in 2023.
“In the diagnostics space, Natera is an industry leader with a host of innovative offerings including non-invasive prenatal testing (NIPT) and other genetic testing. While Natera’s commercial execution was strong in the reported period, the company did not benefit from COVID-testing tailwinds (unlike the large-capitalisation diagnostic players) and share price declines were further exacerbated by the growth-to-value rotation that characterised the year under review. Additionally, the New York Times published an article in January 2022 denouncing the low accuracy of NIPT in identifying rare genetic diseases, and in March 2022, a short seller published a report on Natera alleging illegal billing practices relating to its NIPT business, both of which created significant controversy. Whilst we disagreed with both of these reports, these collective issues created a significant disconnect between the company’s fundamentals and most recent valuation.
“Another innovative player in the diagnostics space is Guardant Health, an oncology diagnostics company that has emerged as the pre-eminent liquid biopsy provider. The company has many offerings in the cancer diagnostics sector including therapy selection, disease assays, and response monitoring. The company also plans to enter the non-invasive screening market in 2022. Unfortunately, the share price experienced a material pullback through the course of the year despite generally strong financial performance. Again, macro-market conditions were largely to blame, but the stock was particularly weak following rumours that it was considering a purchase of another oncology diagnostics company, although the deal never materialised. Again, these collective issues created a significant disconnect between the company’s fundamentals and its most recent valuation.
“Deciphera Pharmaceuticals, is a clinical stage, emerging biotechnology company that is developing small molecule drugs to treat various types of cancer. The company’s focus in recent years has been the continued development of Qinlock (ripretinib), an orally administered inhibitor of specific mutated kinases which otherwise contribute to the development of certain cancers. In 2020, the FDA approved Qinlock for use as a fourth line therapy for gastrointestinal stromal tumours (GIST). More recently, the company conducted a trial to explore the use of Qinlock in earlier lines of therapy. However, in November 2021, that trial failed to show significantly superior results versus the standard of care in second line GIST, Sutent (sunitinib). The stock had traded down along with the broader biotechnology drawdown into this update and subsequently gapped even lower after the failed trial.
“The “XBI” is an exchange-traded fund – SPDR S&P Biotech ETF – incorporated in the U.S. that seeks to replicate the performance of the S&P Biotechnology Index. The Index is equal-weighted, has approximately 150 constituents, and tracks all biotechnology single stocks that are listed on the NYSE, American Stock Exchange, and the NASDAQ National Market and Small Capitalisation exchanges. The XBI offers an opportunity to gain tactical exposure to the biotechnology subsector quickly and efficiently while not exposing the portfolio to unnecessary idiosyncratic single stock risks. Given the extraordinary drawdown in the biotechnology subsector since February 2021, the removal of key sector overhangs, and anticipated mergers & acquisitions (M&A) by large capitalisation pharmaceutical companies, we wanted to gain exposure to a tactical rebound as we went through the year. Unfortunately, our purchase was premature, and the XBI continued to sell off right into the financial year-end. This holding was bought and sold during the year.”
“During the financial year, the Company made four new investments in unquoted companies. Another four portfolio companies – including one of these new investments – completed their Initial Public Offerings (IPOs) in the period. As of 31 March 2022, investments in unquoted companies (excluding debt) accounted for 7.0% of the Company’s net assets versus 5.3% as of 31 March 2021.
“The four new investments this year were all healthcare services companies in emerging markets (one in India and three in China). In the U.S., a challenging public offering market for small and mid-capitalisation therapeutics companies made pre-IPO crossover investments unattractive in the year. Of the four companies that completed an Initial Public Offering, three listed on the Hong Kong Stock Exchange in the second half of the financial year and a biotechnology company listed on the Nasdaq Stock Exchange in the U.S.
“For the year ended 31 March 2022, the Company’s unquoted holdings contributed gains of £21.8m, (including both realised and unrealised gains) equivalent to a return of 15% and those companies that went public contributed gains of £20.7m, representing a return of 35%. While the gains in unquoteds were spread among many companies, the gains for companies that listed were dominated by Shanghai Bio-heart Biological Technology. Overall, the unquoted strategy (excluding debt) contributed £42.5m equivalent to 1.8% of the Company’s net asset value return for the year.”
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