Andy Acker, CFA, Portfolio Manager of the Janus Henderson Global Life Sciences Fund leads Janus Henderson’s Health Care Sector Research Team and offers a unique understanding of the science behind the team’s investments. During this 30-minute discussion – exclusively for our investors – Andy answers questions about how the pandemic and the recovery has impacted the healthcare industry.

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Harvesting Innovation – Investment Opportunities in Healthcare
3/8/22

Great question, Sean. It’s good to be with everyone today. Yes, it’s been a very interesting time in healthcare and really, this dates back to about two years ago when the pandemic first hit. And if we remember back to that time you know historically, it took 10 years to develop a new vaccine and what’s been amazing is that you know, two companies developed highly effective vaccines you know, over 95% efficacy within about 10 months. So this I think, really points to the incredible innovation that we’ve seen in the sector. And so that actually got investors very excited, but there have been some headwinds. That includes political rhetoric around drug pricing, we’ve had increased regulatory scrutiny about M&A, especially large M&A. You know and all of this has driven a substantial underperformance recently in healthcare generally and in biotech specifically and we’ll talk about that. But that has led to attractive valuations we believe in the healthcare sector and especially in certain areas of therapeutics and really disregards the defensive characteristics of the healthcare sector, which we’ll talk about in more detail. And also the long-term drivers, especially the very high levels and accelerating levels of innovation that we’re seeing, addressing high unmet medical needs. So hopefully in the next 30 minutes, we’ll get into more details on those points.

So if we think about where we are you know, we’ve just gone through the Omicron wave and you can see this chart on the left here, that at the peak, we were getting close to 900,000 cases a day just about a month ago. Importantly, that’s come down dramatically, about 95% in just the last six weeks. So now we’re below 50,000 cases a day. And given the high level of vaccination in the US you know, over 65% of people in the US are fully vaccinated. We’ve given out and delivered over 500 million doses in the US. These percentages go up significantly if you think about adults for example, where we’re over 75% vaccinated. So given the combination of vaccination and also actual infections, we think we’re getting much closer to endemic levels. And so hopefully, we’re getting to the end of the Covid pandemic. I am getting a little bit of an echo here, but hopefully everyone can hear me.

And then the question will be you know, are there going to be new variants, and that I think is very difficult to predict. But importantly you know, the population is very different today than it was two years ago. And many of us have developed either you know, resistance through vaccination or through actual infection and so I think that leaves a much smaller, vulnerable population in the US and really around the world as well. So I think we’re optimistic we’ve been through the worst of it and now importantly, we also have very effective treatments to go with effective vaccines. And so for example, there’s now a pill that can reduce the risk of infection by over 90%. So even in the cases where there are breakthrough infections, I think the treatment landscape is far superior today than it was a couple years ago.

Yes, well, it’s certainly been an interesting time. And again if we look back to 2020, we had you know, really a lot of excitement about these new vaccines that were developed, new treatments, diagnostics. You know, the healthcare sector was really front and center in dealing with Covid-19 and I think it highlighted the innovation of the sector that has really led to a boom in small and mid-cap biotech stocks, many of which were able to access the public markets for the first time. Just in the last two years, there were more than 180 biotech IPOs so there was a lot of excitement.

You know, some sectors did suffer a bit especially because everyone was working from home. We didn’t have the normal levels of procedures, we had many cases of cancer that went undiagnosed. Companies that were in the midst of product launches were not able to meet with doctors to detail them about the benefits of their medicines so that slowed down some new product launches. Also patients were not able to meet with their doctor so you know, all of that had a negative impact on some areas. Things really changed in 2021. All of the excitement about especially small and mid-cap biotech turned to worries you know, including political rhetoric that was picking up about potential drug pricing reform. We had a lack of leadership at the FDA so it took more than a year to get a new leader confirmed, which has just happened now. And still you know, sort of M&A activity has been really dormant for the last, especially the last six to nine months relative to what we’ve seen historically.

So with all of those overhangs and especially with rising interest rates now, we’ve seen a substantial pullback in small and mid-cap biotech stocks which we think really creates a compelling buying opportunity now. If we look at valuations in the sector especially in therapeutics, we think these are really depressed relative to the overall market and this is on the next page. But as of you know the year end, large-cap biotech stocks were trading at 11 times earnings or about half the multiple of the market.

Many large-cap pharmaceutical companies similarly, have been trading at a huge discount to the market that we’ve rarely ever seen. Many of these stocks now are trading at you know, 10, 11, 12 times earnings, still a substantial discount to the market even though they have, they really lack the economic sensitivity of many of the other stocks in the market. And so especially with rising inflation, war in the Ukraine and also rising interest rates you know, we worry that that could have an impact on economic activity and really slow things down. We think healthcare would really stand out in that kind of environment.

We’ve also seen a dramatic pullback in small and mid-cap biotech stocks and this is on the next page here, page 7. In fact this you know, small and mid-cap biotech stocks are typically quite volatile. In fact in the last 15 years, the XBI which is an ETF that tracks the average biotech company, so this is an equal weighted ETF in biotech, has had before this year, had 11 pullbacks of at least 20% in the last 15 years. So almost every year you know, this is a volatile sector and you can see that as a psychology, an excitement and fear about biotech waxes and wanes.

But what we’ve seen the last year is really unprecedented. We had a 50% absolute drawdown which was the worst since the creation of the XBI index back in ’06 and it’s lasted about three times as long as the average pullback. And most importantly relative to the market or relative to the healthcare sector, it’s been by far the most severe pullback we’ve seen, over 63% relative to healthcare and relative to the market. So that’s about three times bigger than what we’ve seen historically. But this has created what we believe is a attractive buying opportunity. There are more than 150 biotech stocks that now trade below the levels of cash on their balance sheet. So again, that’s really unprecedented. We think many companies are trading as if they have no pipelines at all and so we’re finding many what we believe, are call options on the innovation that we’re seeing in the sector.

I think what’s also notable is that after a period of drawdown like the one we’ve just experienced, these stocks have historically outperformed by a significant margin. And in the one year after a pullback that we’ve seen historically, these stocks are up over 50% on average and about 25% relative to the market. So you know, we think this sets up between the defensive pharmaceutical and large-cap biotech stocks and many small-cap biotech stocks trading with you know, essentially no pipeline value. We think there’s you know, a lot of underappreciated value within the healthcare sector today.

Yes, it’s a great question. It’s always impossible to nail the exact bottom, but we think we’re you know, we do think we’re getting very close and it has to do partly with the huge number of stocks trading at a discount to what we believe is their intrinsic value, many trading below cash. We have companies that are profitable, that are trading at you know, roughly half the market multiple. But importantly, we’re also seeing an acceleration of innovation and we can see this really on I guess, page 9 if we go ahead.

You know actually, this is, you know what you see here is the number of new products coming to market has been accelerating dramatically. And just in the last five years, there have been over 250 new medicines approved in the US, that’s up over 100% from where we were about 10 years ago. And importantly and what we focus on are companies addressing high unmet medical needs with novel products and those are the ones that we believe ultimately have the potential to become blockbusters. That means they sell at least a billion dollars a year. If we think about it, it costs about a billion dollars to bring a new therapy to market and there’s also a high failure rate. And it also costs a significant amount to market a new therapy. And so we need you know, a product that’s only an incremental innovation that may go on to sell you know, $100 or $200 million, that sounds like a lot, but those products will actually never become profitable because it costs on average about $300 million to market a new therapy. But the ones that can go on to sell a billion or ideally multiple billions of dollars, really drive all of the profits of the industry. So that’s what we look to identify from a relatively early stage.

And you can see here on the chart on the right, the opportunity set has continued to grow. And in fact, when we started the Global Life Sciences Strategy back in 1999, there were really only a couple of biotech blockbuster products that sold over a billion. Today, there are more than 85 of those and generating sales of over $300 billion a year. And you know, we see still substantial growth ahead based on the new products that are coming to market today. And in 2021 even though it was a challenging year without leadership at the FDA, there were still more than 50 products approved and over half of those were for novel mechanisms of action.

Sure, well on the next page you know, we talk about a couple of areas where we’re seeing real breakthroughs. One of these is in genetic diseases. There are more than 7,000 genetic diseases that have been identified and some of these are devastating diseases like hemophilia, cystic fibrosis, muscular dystrophy. You know, many of these cause death for patients. You know, if we think about muscular dystrophy, these are patients that ended up in a wheelchair in their teens and they generally die in their 20s. Sickle cell disease is another one. You know, these have a huge impact on quality of life and also on overall survival. And there’s more than 7,000 of these diseases, many more that are being diagnosed and identified almost every day. But 95% of them currently have no treatment available at all. But with the incredible progress we’ve made in terms of our genetic understanding of the causes of disease and our understanding of disease biology and with new modalities to treat human disease you know, mRNA is something that most investors had never heard of you know, two or three years ago, but is now you know, sort of a common term. We have ways of putting mRNA into a patient to make proteins. We can put DNA into a patient. We can also reduce the levels of RNA to reduce harmful proteins. We have gene therapies, gene editing, cell therapies you know, just all new ways of treating human disease, including precision treatments for cancer which is the number two cause of death, which we’re spending over a trillion dollars a year treating. So we’re making incredible progress and we expect many of these treatments to be launching over the next couple of years.

Also in medical devices, we’re making incredible progress and this is also on the next page. But if we think about diabetes, this is another global pandemic that affects more than 400 million people worldwide. And for patients with Type 1 diabetes for decades you know, they’ve had to stick their finger with a needle to draw blood and to measure their levels of glucose up to eight times a day. Now with new digital technologies, we can put a sensor on your body that can give a readout of your levels of glucose every five minutes on your iPhone. In addition, we’re using things like AI and machine learning to develop algorithms that can combine this kind of sensor with an automated insulin pump that can effectively act like an automated pancreas. You know, so we’re getting incredible improvements in disease management for patients with diabetes.

Similarly, robotic surgery is just a superior way to do surgery. I personally had knee surgery about four weeks ago and I wouldn’t even consider having that procedure done without a robotic assist. Because when you use a robot, it’s more accurate than the human hand and my father was a surgeon for 48 years. But you know, a robot can do things that a human hand cannot. And really, it can give you better accuracy. If you’re doing a knee, a partial knee replacement like I had, you need to be accurate within two millimeters in three dimensions to reduce the friction on that joint. And that makes it last much longer, you get less pain, less bleeding, less time in the hospital. So you can actually save money with these new technologies while delivering much better results for patients.

So you know each of these markets is less than 10% penetrated despite selling billions of dollars a year. And so we think these are products that can grow really not just for a couple of years, but a couple of decades. You know, we think we’re still very early in the adoption of these kinds of technologies.

Yes. So you know, what it has done, I’d say Covid-19 maybe in some cases has slowed things down. But it’s also driven more innovation in terms of for example, remote data capture. You know, so if you can’t visit a clinical trial site to get the data, we’ve now developed ways where you can get that data remotely. So in some ways, it’s actually making clinical trial development more efficient. You know in some rare cases, we’ve seen delays but you know in general, that’s been maybe on the order of six months or so. And so as sites can reopen for example and see more patients, we’re starting to see that come back online.

But I’d say it’s had a modest impact on you know, a few clinical trials. In some cases, it has really slowed down new drug launches. But as we come out at Covid and really as the economy reopens and doctor offices reopen, we’re getting a resumption of you know, standard medical procedures, diagnostics you know, patients, seeing their doctors and being able to get new treatments. So all of those things we think you know in a sense, the Covid losers over the last couple of years that have really been harmed by that are now starting to come back where some of the Covid winners for example, the vaccine companies, which you know in some cases, we thought had gotten to unsustainable valuation levels you know, we’re really seeing some of those companies come back in substantially as we you know, past this wave of Covid.

Yes this is, I think one of the real benefits of the healthcare sector is its defensive characteristics. You know if you think about it, healthcare demand holds up much better than most of the rest of the economy. So you know, the real risk to markets when you have an economic slowdown is that the earnings are not stable. You know in many cases, earnings decline, but in healthcare you know, companies like pharmaceutical companies and biotech companies, the demand doesn’t really change that much even if you go into an economic slowdown or a recession. So I think we’re really seeing that you know, recently with especially with the concerns about the war in the Ukraine, which has really put even more pressure on inflation which could lead to more pressure on interest rates, you’re seeing those defensive characteristics of healthcare really stand out.

And this really shows the last four major downturns of at least 15%, which I think we’re close to now in the overall market. What you can see is healthcare tends to be quite defensive and only falls about half as much as the rest of the market and we’ve been seeing that so far this year. You know, I’d say, we’ve really shifted our positioning at the beginning of this year because of worries about higher interest rates. We you know, we own more of the defensive pharmaceutical stocks that are trading you know, 10 to 11 times earnings in some cases, only 8 times earnings, while the market was over 20 times earnings. The large-cap biotech stocks similarly. The HMOs you know, these are all companies that we believe will be quite defensive and in fact, many of them have been holding up better in the recent pullback.

And then in biotech, I’d say we’ve moved to shorter duration stocks. So companies that have real you know, earnings and/or meaningful sales today, but where we think we’re getting much of the pipeline for free. And so we’re nearly free call options. And so again, those kinds of stocks we think are holding up a little better. And then selectively, we have some of the earlier stage companies that are trading at a discount to cash where we think their pipelines are quite promising and underappreciated.

Yes, so this is a sector that more than any other you know, has a huge disparity.

So the way that you can generate outperformance again, is through an active management approach. On the next page you know, our approach to investing in the sector is something we call the 90/90 rule. And this refers to the clinical and commercial risks of developing a new therapy. So the first part we have to understand is that 90% of the drugs that begin in human clinical testing will never make it all the way to market. And so a big part of our approach is trying to understand the science as well as the business. We have seven senior analysts with over 100 years of experience investing in the sector, focused on the different subsectors of healthcare including biotechnology, pharmaceuticals, healthcare services and medical devices.

And then just going back to that 90/90 rule you know, the second part refers to the commercial risks of launching a new therapy. And again in our experience of more than 20 years of managing the Global Life Sciences Strategy, what we found is the consensus estimates from Wall Street are wrong about 90% of the time. And those estimates can be way too high in which case, that’s a stock that we want to avoid and some of those companies can even go bankrupt. And on the other hand, the ones that where the expectations are too low, especially the ones that can go on and become blockbusters or mega blockbusters and so those are always the ones we’re trying to identify.

Yes, so I think you know earlier this year, we did become a bit more defensive and really have a bit of a barbell approach where we own you know, defensive stocks that we think are at a big discount to the market, but still growing, still with attractive dividends. And then on the other hand, we own innovation on sale you know, so companies where we think they’re trading as if they have no pipeline.

What you can see here is and this is really through 2021 you know, that was not a great year for us, really driven by those small and mid-cap biotech stocks that underperformed so substantially. And we have been historically overweight that group of stocks because that’s where the innovation come. In fact, the majority of the new products today were developed by small and mid-cap biotech stocks.

But what you can see here is on a longer-term basis, we have performed quite well. Over the last 10 years for example, we’ve outperformed. And since the strategy inception, we’ve outperformed our index by more than 400 basis points a year. And also the S&P 500 by more than 400 basis points a year. And so on a longer-term basis, we’ve been performing you know, over the last decade, in the top 12 percentile.

On a long-term basis also and this is on page 20 you know, what we look at is how consistently do we outperform on a rolling three-year basis. And what you can see here is, we have outperformed over the last 15 years, roughly 90% of the time. So you know with the recent pullback, we think this is a really compelling time to be investing in healthcare in general and in this strategy in particular.

Yes, so we’re very close to some significant gene therapies, I think potentially becoming a reality. So one company recently announced positive pivotal data for a gene therapy for the treatment of hemophilia. You know these patients, many of them are still getting multiple infusions every week, essentially for life to get just a modest level of control over their disease. Here we have a gene therapy that would be a one-time treatment, where you’re actually turning the cells of the body into a factory that can produce Factor VIII, which is this missing clotting factor for hemophilia patients. So that product will be filed next quarter in the 2nd Quarter of 2022 and potentially launch late this year or early next year. So that’s one we’re excited about.

Another company has a gene therapy for Muscular Dystrophy again, devastating disease with no treatments really available that can be disease modifying. Here again, we’re giving a smaller version of the missing or defective dystrophin protein which is the shock absorber for muscles and we think this treatment is extremely promising. It’s pivotal Phase 3 three trials right now. We expect that to report out in the first half of next year.

And then I think later this year, we’re going to get several trials that will report out on Alzheimer’s disease. So there is one treatment available today, but you know Medicare, that data was sort of mixed so we’re going to get several additional pivotal trials for Alzheimer’s disease to see if we have a real disease modifying treatment for Alzheimer’s. That affects you know, millions of people in the US and tens of millions worldwide so that will be another important data point.

And just really you know, many other therapies that are coming between gene therapies, gene editing, diseases like ATTR amyloidosis, which is a cardiac disease where patients that are diagnosed only have three to five years to live. We think that affects about half a million people, about 10% of people with heart failure really have this amyloidosis and we think there’s several very promising treatments including a way of knocking down the RNA that makes that protein as well as gene editing where you can have a one-time treatment that can impact that disease potentially permanently. So you know, just really too many exciting companies and exciting products that we think will be coming to market in the next few years.

But you know, the things that we’re seeing today would again, would have seemed like science fiction you know, 10 years ago in terms of all the different ways we can address human disease. And that has us extremely excited about you know, what we believe is a revolution in biology that we think will take place you know, not just over the next couple of years, but over the next couple of decades. So that has us extremely excited about the sector.

Great. Thanks, everybody.