Innovation, Demand and Regulations
Alger Health Sciences Fund
Author: Ticker Magazine
Last Update: Feb 04, 11:21 AM EST
|As one of the largest sectors of the economy, healthcare continues to grow driven by demand and innovation. However, the healthcare space is far from easy to navigate due to its dependence on government regulations, an unavoidable part of innovation. Teresa McRoberts, portfolio manager of the Alger Health Sciences Fund, focuses on key new products and pursues long-term growth, while being cognizant of the idiosyncratic risks in the sector.
“We believe healthcare is driven by innovation, demand and government regulations. That makes it a very idiosyncratic group. We look for innovation and new products that can generate alpha, because a good new product can be extremely profitable for a long time.”
Q: What is the history and core mission of the fund?
I have been managing the Alger Health Sciences Fund for four years. It has been managed as a diversified fund since its inception in 2002. Our core mission is to deliver the best performance possible for our investors, so the fund does not hug its benchmark. Within healthcare, there’s usually a subsector that is doing better than another subsector, and we tend to gravitate towards it.
We believe healthcare is driven by innovation, demand and government regulations. That makes it a very idiosyncratic group. We look for innovation and new products that can generate alpha, because a good new product can be extremely profitable for a long time. Over the years, we have seen many instances where a new product was expected to generate $100 million or $200 million, but turned out to be 10 or 20 times bigger.
Even in the 2000-2002 bear market, some healthcare stocks did extremely well – actually going up. We search for healthcare stocks offering an innovation that patients and/or physicians will value. If someone has found a new way to meet the demands of patients and doctors, that is usually a good business. So, healthcare is a great place to find alpha and deliver superior performance, but given the complex nature of healthcare, an experienced manager with deep knowledge of both the financial side as well as the regulatory side is essential.
Q: Why should investors consider the healthcare sector?
Healthcare is a core sector of our economy, comprising 15% to 18% of the GDP. As a nation, we spend a lot of money on healthcare and demand is a major driver. Demographically, about 10,000 people a day age into Medicare. That trend has continued in the last four or five years and will continue for another four or five years.
As we age, we use more healthcare, so demand is driven by demographics. There is a growing demand in the emerging markets as these economies develop. In addition, the Affordable Care Act, or Obamacare, gave access to subsidized health insurance or Medicaid to approximately 20 million people in total. With access to health insurance, more people are accessing healthcare.
The demand is always there; the question is whether it is affordable and accessible. Over the last few years demand has increased and, as a result, the innovative products are doing better. I doubt that we will take away Medicaid from all the people who have gotten it through the ACA expansion. Overall, healthcare is too big and important to be ignored as an investment area.
Q: How important is the regulatory environment? Is the government a friend or a foe?
Washington can be a friend, a foe, or a non-factor. When there are no major regulatory changes, it can be a gentle background noise, an administrator of product approvals and Medicare payments. But at times the noise in Washington is quite loud. The healthcare sector had a period of underperformance while the ACA was being debated by Congress and early in implementation. , but once it was settled and investors understood the significant increase in the access to healthcare products and services, the ACA actually had a positive effect on the stocks.
The FDA has been very positive for the industry. In 2018 it approved the greatest number of new products in its history. The FDA is very forward-thinking in terms of streamlining approvals and are trying to be efficient in communicating approval requirements, because they want new products out to patients quickly. Many stocks had positive stock performance because of the rapid FDA approvals of their products and we expect this to continue to be a positive for the next several years.
On the other hand, the president has been critical of the pricing of pharmaceutical products and has proposed some new regulations to address pharmaceutical pricing. It is not easy to find the political balance between not scaring away investors in risky pharmaceutical development projects while trying to give patients and physicians new treatment options. Over the coming years, I expect that we’ll experiment with approaches to balance the conflicting demands of lower prices while continuing to innovate to help patients. Right now the news from Washington is not as disruptive as during the time of the ACA, when people were talking about restructuring 16% of the GDP.
Q: What core beliefs drive your investment philosophy?
We believe that healthcare is a growth area, driven by demographics and innovation. As long as illnesses need treating, curing, or better therapy, the growth should continue. I believe that healthcare is a long-term growth area and demand will continue to increase.
We differentiate ourselves by our long-term focus and the focus on new products. I invest only where I believe the new product is working and the story is intact. Healthcare is a diverse sector with many areas, but this is a growth fund at its core. In healthcare, growth means that we are helping somebody feel better. The sector is not just about the money; it is about helping someone feel better, live longer and have better quality of life.
Q: What are the key steps of your investment process? How do you generate ideas?
It’s rare to come across a name that I don’t know, because we have owned almost every major stock at some point. We are familiar with the core drivers of each stock, so our interest in a name can be prompted by new data or changing Washington regulations that we think is important for the stock.
The core factor is whether an event would lead to a change in the company’s fundamentals. Product companies go through clinical trials and FDA filings, so there are many public data points along the way. That allows us to refine our view and to carefully consider our investment. The same is true about the service companies, which are affected by Washington’s decisions. Given politics, many things that can happen in Washington and we must understand them.
The process really starts with understanding the positive drivers behind a stock. That usually is an event that we believe will make people excited. Some of our most successful investments have been in stocks that people were not focused on yet. We can be a little bit more patient and focus on things that are coming in years and potentially make outsized returns once the excitement comes.
Q: Do macroeconomic views influence your process?
We do look at the macro picture, although our process evaluates one company at a time. When the economy is slow, healthcare can be a defensive area, so I may want more of certain types of stocks. I understand that certain sectors work better in specific markets and I try to overweight them when appropriate. For me, the macro aspect is not just the economy, but also the political environment and the risk appetite, because the risk appetite drives the willingness to invest in biotech.
Q: What other factors have an impact on the team’s due diligence process?
Our analysts are focused on their individual subsectors. For the stocks that we own, we visit the companies in their offices several times a year. We also see them at conferences and listen to conference calls.
However, talking to the companies in this space is not enough. We also spend time at medical meetings and on Washington regulation to understand what might happen.
Recently one of our companies had impressive data. At the end of the presentation at the medical meeting, probably 5,000 doctors in the room stood up and applauded. That’s not a usual reaction and, therefore, we knew it was important data that was well received by the medical community. The first line of product approval is the doctors. We also listen to FDA panels when they review a new product that is being considered for approval. We have to invest that time and energy to understand where the product or service will fit when it comes out.