Blog: Paul and Brett’s Alpha November 2020
Paul Major, Brett Darke – Portfolio Manager
The monthly BBH factsheet and commentary is always thought provoking and elicits a wide range of responses and views, here at the Trust we thought it would be a good idea to make the portfolio management teams commentary available in form of rolling 12 month blog, as always any comments and observations are welcome.
“Another lap around the sun”
Before we discuss the month’s key developments and the Trust’s performance during that period, November also marks the end of BB Healthcare’s fiscal year end and the anniversary of our listing. At inception, we asked investors to judge the effectiveness of the strategy based on rolling three-year performance versus our comparator index; the MSCI World Healthcare (measured in GBP).
We have reproduced this data in the table below and are pleased to report that we have met our twin ambitions of beating the MSCI comparator’s performance and delivered teens annualised returns over that three-year period.
We are also pleased to report that we passed the 100% total return since inception in US dollar terms during the month (it was 103.8% by month end) and the Trust’s market value is now north of $1.1bn. Our portfolio has tended to have >90% dollar exposure since inception and we do not hedge our currency risk. As such, as the dollar is arguably a more representative currency for measuring portfolio alpha.
It bears repeating that, whilst the SARS-CoV-2 pandemic has been a hugely disruptive and emotionally challenging period, we do not see any negative impact from it on the longer-term outlook for healthcare. As such, we see no reason to change those longer-term aspirations for the performance of our investment strategy. It is also worth noting that the gross assets under management have grown from £312m to £843m over the last three years.
We remain confident the current strategy can accommodate substantial additional asset inflows and, as such, we are happy to see the Trust continue to grow via new issuance.
The US political outlook
Only in the self-described “world’s greatest democracy” can we still not know the definitive outcome of an election for several months after the voting is over. All being well, the Electoral College will follow the will of the people and lend the majority of votes to Joe Biden, who also seems to have won the popular vote by some distance amidst a record turnout.
Meanwhile, Trump looks set to continue to pursue legal remedies for recounts etc., despite being overwhelmingly unsuccessful in these challenges thus far. In the interim, it is not really apparent how engaged Trump is and what, if any, wider objectives will be pursued between now and the transition of power in late January.
One could rightfully devote pages and pages to the various and serious failings of the 45th President’s Administration, but what point would it serve? What’s done is done and generally speaking, can also be undone. We would instead offer a quote from consumer champion, FDA co-founder and 26th President Theodore Roosevelt: “The best leader is the one who has sense enough to pick good men to do what he wants done, and the self-restraint to keep from meddling with them while they do it.”
Surely no statement more aptly captures the dysfunctionality at the heart of the (soon to be ex) Administration. The early signs are that Biden will not be repeating the folly of avoiding dissenting opinions or expecting fealty. So what will define the Biden-Harris Administration?
The transition team website lists four priorities and healthcare isn’t one of them: fighting COVID-19, economic recovery, racial equality and climate change. This is a good thing for healthcare investors. As we know, the legislative process in the US is intentionally laborious and time-consuming. Passing any legislation requires two bills in two houses and then a process of reconciliation. The Democrats have retained control of the House of Representatives.
However, the Senate looks unlikely to fall to the Democrats; 98 of 100 seats are resolved: 50 for the Republicans, 46 for Democrats and two for independents (Sanders for Vermont and King for Maine) who nominally caucus with the Democrats. The two remaining seats in Georgia will be decided in a special election in January and both seats are currently held by Republicans.
The special (i.e. runoff) election is being held because neither candidate for each got the threshold 50% that State law requires. On the popular vote, one swung toward its Republican incumbent, the other turned Blue. As such, it seems reasonable to expect the state to go 50/50 (although there is some concern in Republican circles that Trump’s attempts to deem the election illegitimate will turn off some centrists who voted Republican in the first round). This would leave the Senate in Republican hands at 51:49. In this circumstance, if any vote were to go to a tie (due to a Republican crossover), then the Democrats could win via VP Harris casting the deciding vote.
In summary then, Biden is going to struggle to pass any contentious legislation before the 2022 mid-terms potentially shift the balance of power in the Senate once more (he hopes in his favour). Either side can still frustrate the passage of legislation through the Senate via the filibuster, as no-one has a 60-seat ‘super-majority’.
What does this mean in policy terms? Fighting COVID and the economic recovery will themselves be contentious issues; one need only look at the battles over much needed stimulus packages even when the Republicans held two of the three branches of government.
There will be precious little bandwidth for widespread healthcare reforms. Getting Trump-era cuts to ACA funding and enrolment windows reversed will be an obvious place to start, but wider reform may wait until after the Supreme Court has clarified the fate of the individual mandate (so far, we have only heard the oral arguments and there were some positive noises regarding severability, but we would urge caution in over-interpreting the initial comments regarding any final ruling). In conclusion then, it is a Goldilocks scenario for now. If the court strikes down the mandate or the law more broadly, that would be an issue but this is a ‘known unknown’.
“Ending global freeloading”
What about drug pricing, the perennial popularist’s political football? Trump has repeatedly tried to legislate on this issue via executive order, taking his ‘America First’ ethos into drug pricing by invoking a ‘most favoured nations’ (‘MFN’) approach to reimbursement, where the 50 most widely used Medicare Part B drugs would have their reimbursement phased down to an international comparator level (the ‘MFN price’) over four years. Medicare Part B drug spend was ~$30bn in 2019 and the 50 drugs accounted for ~$22bn of this total.
Per CMS, the MFN Price will be based on the lowest GDP-adjusted price paid by any country that was an OECD member on October 1, 2020 and has a PPP adjusted GDP per capita that is at least 60% of the US. It has been estimated that the programme could ultimately reduce spending on these 50 drugs by$9bn per annum.
Will it (finally) happen? It has been variously suggested that the programme will be tied up in litigation or dropped by the Biden Administration. However, the underperformance of the US Pharma sector versus wider healthcare year-to-date (by around 600bp) suggests that the market is pricing in some sort of policy headwind.
The second aspect of Trump’s “war on drug pricing” is to remove the safe-harbour provision for rebates on Medicare Part D drugs except when they are directed to patients at the point of sale. Currently rebates paid by manufacturers to so-called Pharmacy Benefit Managers (‘PBMs’) can be used for any purpose, including subsidising the plan provider’s wider healthcare costs. Simply put drugs will appear cheaper but premiums and co-pays for a given level of coverage may rise.
Will the net cost to Medicare recipients rise or fall? This is difficult to know; it could be a zero sum game or it could even increase overall consumer contributions. Part D drug costs were around $130bn in 2019, with the Government paying around 75% of the costs.
This one is all about the ‘optics’; the outgoing Administration will be able to claim, without recourse to fake news, that it has lowered drug prices for tens of millions of seniors. The rule becomes effective in January 2022, so again there is plenty of time for industry lobbying or for Biden to throw it out.
Vaccines, vaccines, vaccines – let battle commence
The scores are in and the mRNA vaccines from Pfizer/BioNTech and Moderna look better than decent. Strong initial protection across age cohorts and manageable transient adverse events leave us in a position as good as anyone could reasonably have hoped for. We also have data for the Russian Sputnik 5 and Oxford/Astra conjugate vaccines, although these raise many questions in our minds.
There are still many things we do not yet know – do these vaccines prevent person-to-person transmission of SARS-CoV-2 or just symptomatic COVID-19?How long do they confer protection for? How long does natural immunity from exposure last and does that also prevent transmission? How confident can one be on long-term safety with vaccines using novel technologies such as these?
As we detailed last month, these are critical questions because the societal restrictions that we have all had to live with can only be justifiably rolled back when the risk to those susceptible to morbidity is deemed low enough and that is unlikely to be achieved through exposure-driven herd immunity.
Surrogate markers/correlates of protection (e.g. antibody titres, CD8 T-cell assays) from the studies completed to date have not proven very useful. We know antibody levels fell rapidly post immunisation in both mRNA vaccine phase II cohorts but protection was still very good in phase III. We also know that the CD8 assay data for the Moderna vaccine did not look that good but still the level of protection was very high (Pfizer did not conduct a comparable assay). Antibody levels in the elderly were much lower (as expected), but this did not correlate with the degree of protection being similarly impaired. As such, we are still in the dark on the questions above and only time is going to tell us the answers.
The most vexatious aspect of all this is determining uptake. We can be certain that demand will outstrip supply well into the new year (the UK is not expected to receive its order of 7m doses from Moderna until March for instance), with respect to offering these products to those most likely to benefit from them (the elderly, the vulnerable, those frontline staff at much higher risk of accidental exposure to infected people). Here, the risk/reward is obviously positive.
Until a reasonable proportion of these higher risk groups have been vaccinated, we are unlikely to see a long-term decline in hospitalisations for symptomatic disease. We expect this is going to be the litmus test for political acceptance of restriction rollbacks and thus a true return to pre-COVID norms.
Thereafter, one must try to break the cycle of transmission for what is in essence now an endemic pathogen. Assuming the vaccine does help in this regard, this can only be achieved through widespread uptake and herein lies the challenge.
Let us use ourselves as an example. Your managers are both below 55 years of age, lacking pre-existing medical conditions and, whilst we could always do with losing a few pounds, are not obese. Our headline risk of morbidity from COVID is thus very low and our backgrounds and jobs leave us in a position where we know there are still many things about the vaccines that are not yet clear.
Where then is the incentive to get vaccinated when there are still so many unknowns? Objectively, we see little personal reward and uncertain personal risk. There is the argument that, as a potential link in the chain, we should get vaccinated for the “greater good” but firstly we still do not know if vaccination does reduce transmission and secondly at least one of us has already experienced symptomatic COVID (and recovered), so does this even apply? We could both be immune already.
In truth, we are likely to be at the back of the queue based on disease risk and there will be a lot more data by the time we are potential candidates, which makes the whole decision process so much easier. Indeed, the UK government released its vaccine prioritisation guidelines on 2nd December and we are not deemed high enough risk to qualify for either phase I or phase II of the planned rollout.
These are the discussions that everybody in the world will soon be having and you cannot sidestep the incontrovertible reality that no-one was given one of these vaccines before May 2020 and the numbers of patients with multiple months of exposure is tiny. Thus, the long-term risk/benefit remains unknown.
We want to be clear on one point: historical precedent suggests that the risk of a vaccine revealing unexpected and serious adverse events once it is used in a wider population is VERY low. Whilst there have been the inevitable cases of vaccine batches being recalled for manufacturing or contamination issues, the last time an approved vaccine was withdrawn from the market due to an unexpected side effect was RotoShield in 1999.
Many other cases of alleged side effects (e.g. Lymerix causing auto-immune problems in 1999, Menactra causing GBS in 2005) were concluded to be fallacious, based on the retrospective analysis of millions of recipients. Most vaccines that fail in phase III clinical trials do so not due to unexpected adverse events, but due to efficacy failing to live up to expectations - there is no point vaccinating people if the level of protection is very low. This is an easy point to make if you have looked at all of the data, but most people have not and will not get the opportunity to do so, they will need to have their hands held on this point.
That said, we have never been in a position where a vaccine has been rolled out so quickly. The onus is thus on the authorities to dispel people’s understandable concerns and this relies on credibility, which is certainly not the strongest facet of the current UK government, and Trump’s apparent desire to overlook clinical data for political expediency, coupled to the FDA’s rapid approval of two purported COVID treatments that were then shown to be ineffective will not so quickly be forgotten by the US public either. Nature abhors uncertainty and there will be no shortage of theories to fill the void.
Let us come back to the investment outlook. We have a situation where apparently rational politicians (is that an oxymoron? We aren’t sure anymore) are talking about life beginning to return to normal after Easter. How does work in reality? As we noted last month, tens of millions of people will need to be vaccinated to achieve anything close to herd immunity. The logistics alone are daunting. Then we have the question of willingness. No ‘sensible celebrity spokesperson’ is going to be able to assuage those who want to see more data and wanting such data does not make you a crazed “anti-vaxxer”. Only more data is going to suffice and only time can provide it.
The carrot of more data aside, there is the stick of not being able to participate in the fabled re-opening if you are not vaccinated. We have already had the CEO of Qantas state that a certificate of vaccination will become a pre-requisite to fly on the airline and that he expected other carriers to follow suit. Additionally, our own recently appointed UK Government Vaccine ‘Tsar’ Nadhim Zahawi MP (relevant biomedical and public health experience: none, of course) has suggested integration of a vaccine certificate into the ‘world-beating’ NHS test and trace app and that leisure venues would be in their rights to deny the unvaccinated entry. It does appear the Government is now rowing back on this in light of public opprobrium, but the damage is probably done in many people’s minds.
This level of apparent coercion will be manna to conspiracy theorists. One can just imagine them furiously pounding their phones, posting to social media that location tracking nanobots in the vaccine will soon know your every move; failing to acknowledge those very same social media Apps and phones have been tracking them very effectively for years now. Never has the dystopian autocrat needed nanotechnology less: China has created a surveillance state already; if you want to follow suit, the template is there. Don’t fear the needle, fear the Apps!
To our mind, many public health experts seem overly complacent about the reality of the ideological battle ahead and that complacency in turn influences broader market sentiment. We have already received one strategy piece from a ‘bulge-bracket’ investment bank arguing that 2021 will see an unleashing of animal spirits and that people should get on board the cyclical equity recovery train that set off in November.
These sorts of calls can be self-reinforcing and thus to an extent will work; to the detriment of defensive sectors like healthcare. Indeed, this rotation into recovery has been the defining narrative of the last few weeks. Of course, if the momentum in share prices is not followed by an upswing in forward guidance and reported results/trading statements then it will snap back the other way.