Healthcare Stocks Are Priced for a Fire Sale. These 6 Funds Can Ride Them Higher.

“At one point in October [2023], we had 232 biotech companies trading below the levels of cash on their balance sheet,” says Andy Acker, co-manager of the
Janus Henderson Global Life Sciences
fund. “That’s the most ever reported.” Acker took advantage of the decline, building a position in ImmunoGen, which makes effective ovarian cancer drugs. In November,
AbbVie
announced an acquisition—since completed—of ImmunoGen, and the latter’s stock quickly doubled.

Since Oct. 31, as the panic about rising interest rates and inflation abated, the
SPDR S&P Biotech
ETF has gained 40%. Because biotech companies often depend on external financing to support them during their drug development stage, rising interest rates on debt hurt them. But that’s over now.

Actively managed mutual funds make sense with healthcare. Consider that many healthcare companies’ future earnings are dependent on drugs that haven’t received regulatory approval yet. Those future prospects are often difficult for the market to price efficiently and thus hard to capture in an index fund.

“Healthcare is the least-efficient sector,” Acker says. Over the past decade, “the top biotech stocks each year have nearly quadrupled, while the bottom five stocks have lost almost 80% of their value. A single clinical drug-trial data point could be the difference between a massive success and another product that will completely fail.”

There are excellent actively managed healthcare funds. Yet it’s important to understand their strategic differences.
Vanguard Health Care
“is a very large healthcare fund, the biggest in the world,” says Rebecca Sykes, the $46 billion fund’s co-manager. “That’s important because it partly determines the purpose of the fund.”

Indeed, because of the Vanguard fund’s size, Sykes focuses primarily on larger, steadier healthcare stocks, not the more volatile, smaller biotech companies. While healthcare is generally a growth sector, Sykes’ stocks tend to be more reasonably valued, and she holds them for a long time.
Eli Lilly
is the fund’s largest holding and one of the hottest stocks, thanks to its diabetes and weight-loss drugs, Mounjaro and Zepbound.

Yet because Eli Lilly has soared over 130% in the past year, Sykes has been gradually trimming her position and instead building one in
Novo Nordisk,
which makes the rival weight-loss drug Ozempic. Given the drugs’ earnings potential, neither stock is cheap, but Novo’s 38 forward price/earnings ratio is less than Lilly’s 62. “We are constantly assessing the relative valuations of each,” she says.

Sykes also has a 3.7% stake in
Pfizer,
down 32% in the past year with a 12 P/E. It has suffered from a coming patent expiration for its blood-clot medicine Eliquis as well as a decline in Covid vaccinations. But Sykes sees promise in its own obesity drug in development as well as an “excellent bladder cancer drug.”

Vanguard has a fairly balanced approach, but other managers have more of a growth or value tilt. Consider
Baron Health Care.
It can invest in smaller, more rapidly growing companies—being 37% invested in small- and mid-cap stocks, according to Morningstar. This tactic has paid off, with the fund delivering a 13.6% five-year annualized return, besting 98% of its peers. But the fund falters when growth stocks are out of favor, as they were in 2022, when the fund fell 17.1%. Vanguard Health Care, by contrast, lost only 1.1% that year.

“Every 10 years, there are five to 10 [healthcare companies] that will have multiblockbuster potential,” says Baron Health Care manager Neal Kaufman. “We are keenly focused on finding those.” The fund has 20% of its portfolio in biotech, one midsize favorite being
Legend Biotech,
which manufactures an infusion treatment for bone-marrow cancer called Carvykti. “It’s $500,000 for a one-time course of treatment—about a month of an experience, and then you get a long-lasting response for years afterward,” he says. “There’s just huge demand, and Legend can’t make it fast enough.”

Putnam Global Health Care
is more defensive and value-oriented. Manager Michael Maguire avoided a lot of the overpriced biotech IPOs coming out of the pandemic in 2021, and the fund fell only 4.7% in 2022. Instead, he started building his position in robotic-arm surgical equipment maker
Intuitive
Surgical, which also fell in 2022 and early 2023. “A year ago, there was controversy because people were waiting for the company to launch its next-generation robotic platform, and it didn’t come in the timeline investors wanted,” he says. “We think it has a phenomenal technology.”

Maguire’s style can be characterized as “growth at a reasonable price,” as he won’t touch deep-value stocks like Pfizer. One can say a similar thing about Ziad Bakri, who has built an excellent record at
T. Rowe Price Health Sciences
investing in healthcare stocks of every size, but taking smaller individual bets in the riskiest biotech stocks.

Gradually, Bakri has been building a position in
Argenx,
which he first purchased during the company’s initial public offering in 2017. The company’s autoimmune-disease treatment Vyvgart, a likely blockbuster drug, didn’t receive final FDA approval until 2021. “Argenx started as a very small investment,” Bakri explains. “Then it turned in some clinical data, and the drug works, so we bought more. It got through the FDA approval, and we’ve kept building a position.”

Such a cautious active approach is essential for success in a sector with explosive ups and downs.

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