Lara Castleton: Hello and thank you for joining this episode of Global Perspectives, a podcast created to share insights from our investment professionals and the implications they have for investors. I’m your host for the day, Lara Castleton. Today, we’re digging into one of the sectors that’s most closely tied to our lives, health care. To do this, I’m joined by Andy Acker and Dan Lyons, portfolio managers on our healthcare and biotech strategies, each with over 25 years of experience. Gentlemen, thank you for joining.

Andy Acker: Good to be here. Thanks.

Castleton: Health care is one of the sectors that is really tied and personal to each and every one of us. It’s also a sector that has some of the most divergent characteristics in terms of defensiveness and offensive upsides. I want to dig a little more into the themes of health care today and give our listeners just some of the expectations in terms of opportunities and expectations going forward. I think to start, we have to talk about biopharma. There was a lot of investor enthusiasm surrounding that sector after the pandemic. Andy, broadly, what’s the sector been up to since in terms of R&D?

Acker: Well, it hasn’t been sitting still. Let’s remember what happened three and a half years ago when the COVID-19 pandemic hit. Back then, if we think about history, it used to take 10 years to develop a new vaccine and the fastest ever was four years. Now, fortunately, for the world, the pharma industry has advanced well beyond that, and using new mRNA technology, we were able to develop two highly successful vaccines in about ten months instead of 10 years. These vaccines were over 90% effective. That probably saved millions of lives.

Since then, we’ve made further advances in mRNA technology, but we’re also making advances in other gigantic unmet medical needs. Think about obesity. Obesity has been in the news recently, but we now have therapies that are dramatically more effective than ones that we used to use maybe just ten, or 15 years ago. We’re now getting injectable therapies that are once a week that can give 15, even 20% weight loss. And that was really unprecedented. And these drugs are fairly safe and they’re also improving diabetes as well.

For diabetes and obesity, these new therapies are called GLP-1 therapies. Drugs like Wegovy, Ozempic, and Mounjaro are game-changers now. There was a big question also about if you could get this kind of weight loss, would that also actually improve cardiovascular outcomes like heart attack and stroke and ultimately death. And we now know the answer is yes. In fact, just recently we had new data that showed that you could actually cut the risk of those events by 20% by improving weight loss. This is a big breakthrough.

Let’s think about dementia. Affects over 50 million people worldwide. Unfortunately, as we get older, our probability of getting dementia continues to increase. Until recently, we’ve had no therapies that could modify the disease. Again now, we have new therapies that are antibodies that can go into the brain and actually remove the plaque that is thought to be the main cause of Alzheimer’s disease. The first of these was just approved this year and we have a second one coming in the coming months. These therapies now are the first disease-modifying therapies that are proven in clinical studies to slow the progression of disease that can slow the loss of cognition that’s inherent to this disease. Areas like dementia, Alzheimer’s disease, obesity, and diabetes, are areas that are huge unmet medical needs that are now being revolutionized by new therapies. This is just some of what’s happening in the pharmaceutical industry.

Castleton: Yes, that’s already sounding like a lot and can generate a lot of enthusiasm already. Dan, is there anything else that you’re seeing from your end?

Dan Lyons: Yes, I would just emphasize, building off of Andy’s points, we’ve seen a whole range of new modalities coming through the industry in terms of ways that they can tackle different diseases. Things like gene therapies we can specifically go after the missing gene. Or cell-based therapies, where companies are able to retrain the immune system to fight cancer.

But building off of what Andy talked about with mRNA as a platform, we’ve actually seen that being potentially useful now for infectious diseases more broadly. The industry is working on combined flu-RSV and other respiratory viral diseases that plague us every fall. And what the industry is using this platform now is a versatile way of tackling these diseases by basically having a single shot where you could get a vaccine against not only COVID but also flu and RSV. These are in various stages of clinical development right now, but the mRNA platform could allow the industry to do a better job of harnessing exactly the right antigen, such that the efficacy of things like flu vaccines could improve. We’ll find out if this works out over the coming years, but it’s an example of how a new modality can really broaden the effectiveness of therapies for the industry.

Acker: Yes, and when you think about what did COVID bring forward, where are we going to advance further because of COVID? I also think about diagnostics because when we think about respiratory disease, we all know that we get sick, but we don’t know what’s causing it. Is it a bacteria? Is it a virus? Which type of virus?

We now have point-of-care testing that has been rolled out around the country and around the world that can tell you, when you’re sick, do you have COVID, do you have RSV, do you have flu. Wouldn’t it be better if we could get a more accurate assessment of what’s actually causing your sickness? And you could get direct point-of-care testing and find out in the next 10 to 15 minutes which virus you have. You could get vaccines that could cover many of these different respiratory diseases every year. We could all be a lot healthier. Our kids could go to school more often and have fewer sick days. That would be great for all of society, I think.

Castleton: I mean, as someone with two young kids, and also a fear of needles, all of this is sounding good to me personally. A lot of innovation within the sector in general. A lot of excitement. Biopharma historically has been one of the more defensive ballasts within the healthcare sector. It is not without its headwinds. There are some concerns, mainly around pricing. We saw the Inflation Reduction Act in 2022 get priced. That raised some concerns initially. So, as we think about some of the headwinds, Dan, what do you think in terms of pricing? Is that actually a concern for biopharma and what are the implications from the IRA?

DL I would start off the question with just a broad thought that, in general, whenever we see real innovation in the industry across many different pricing systems around the world, innovation is paid for ultimately. I think that’s the most important thing to keep in mind. Going specifically after the IRA, however, we did recently see the first list of drugs that are going to be subject to negotiation by the government, which will start in 2026 to come out. Now, everyone had been anticipating this for many years because it had been known that this was going to happen.

And what this basically did was just highlight drugs that are already going to be going off-patent or face generic or biosimilar competition. So, in terms of a change in the industry’s fundamentals, it didn’t really change that. In fact, when the first list of drugs subject to negotiation came out, the stocks didn’t really react very much because it was widely anticipated. The legislation basically anticipates roughly a nine to 13-year life cycle for new therapies, and while that could be longer, we would certainly argue it does somewhat coincide with the normal patent life cycle. As a result, it opens the way for new innovative therapies to gain reimbursement in the healthcare system. We think that overall, the IRA effects are quite manageable for the industry.

Acker: And I think the drug price negotiation aspect of the IRA is something that is very high in the minds of investors. I think the part of the bill that’s less appreciated is this element of reducing the co-pays that individuals have to pay. In the United States, in our Medicare system for the elderly, today there is really no limit on how much a patient could have to pay out of pocket for therapies, even if they’re life-saving therapies. If we think about an oral cancer drug, for example, sometimes patients are being asked to pay as much as five or $10,000 out of pocket per year for life-saving therapy. That should never happen. Many people can’t afford that.

Today, one-third of prescriptions are not filled at the pharmacy because of the cost of the co-pays. It’s not necessarily the price of the drugs that is the issue, it’s our current reimbursement system that puts a high burden on the individual patient. The bill actually does start to address that. For Medicare individuals, it limits the amount of out-of-pocket costs for these therapies to no more than $2,000 per year, no matter how many therapies they’re on. That’s actually a big benefit for patients that can improve access and may actually increase demand for pharmaceuticals. That’s an element that we thought was really positive in the bill that maybe is not as well appreciated.

The other element is whenever I hear about there’s a lot of innovative new therapies, people worry about the cost of them, and can this system afford all these new medicines. I think the part that’s less appreciated, again, is that these products are essentially on a treadmill. Because today, we’re spending billions or tens of billions or hundreds of billions on old innovations, products that were developed and brought to market 10, 12, sometimes even 15 years ago.

What is not as well appreciated is that as those products start to lose their patents and face generic competition or biosimilar competition, the price comes down dramatically, sometimes by 90% or more. And so, we’re now getting, essentially, a rebate of billions or even tens of billions of dollars every year from the old products that we’re not paying for anymore. This year, recently, Humira, which had been the biggest drug in the United States, selling over $16 billion a year, is now facing biosimilar competition where the price has come down in some cases by 80% or more.

So, the system is saving billions and billions of dollars on old therapies, which it can then reinvest in newer, more innovative therapies, addressing high unmet medical needs. That’s an underappreciated aspect of the system that has been happening for the last 30 years. For the last 30 years, the percentage of healthcare spending from new medicines has actually not changed. It’s been around 18 to 20% for the last 30 years, despite the fact that we have all these new therapies coming out today that are addressing high unmet medical needs.

In fact, just in the last five years, we’ve had almost 250 new medicines approved in the United States, which is up about 100% from the number of new therapies that were coming in ten, to 15 years ago. We have a lot more new therapies. Many of these are revolutionary products addressing high unmet medical needs. And yet, the total spending on medicines hasn’t really changed.

Castleton: Maybe some misconceptions there in terms of worries about pricing and the big biopharma names. And then, regulation. Dan already touched a little bit in terms of regulations surrounding the IRA. But there’s also regulation, of course, with the FTC. We did see earlier in the year the FTC contested one of the largest proposed biopharma mergers. What impact did that have, and do you see any concerns on FTC regulation going forward?

Lyons: Yes, so earlier in the year there was a contest to the Amgen-Horizon merger, which was a large biopharma merger, and that may have put a damper a bit on large M&A in the sector. More recently, we’ve actually seen that dropped and that merger is likely to go through. I think the long-lasting impact of that probably will be pretty minimal. However, even in that backdrop, year to date, we’ve seen an unprecedented level of M&A activity for the sector with more than a dozen buyouts that were more than a billion in total spending by the pharma companies.

And so, within that backdrop, it just highlights the need that large pharma companies have for innovation. Typically, they get about two-thirds of their innovation from small and mid-cap biotech companies. And this is where we think a lot of the innovation in the sector is, and will be, going forward. That’s why we still see a very positive backdrop for continued M&A within the sector.

Acker: Yes, and M&A I think has been a theme in almost how the industry works. Because as Dan mentioned, 65% of the medicines that reach the market today were initially developed by small and mid-cap biotech companies, and 65% of the pipeline today is being developed by small and mid-cap biotech companies. It’s the smaller companies that are bringing the new innovation in many cases. And then, you have the major pharmaceutical companies that need that innovation to offset their patent expiration so that they can continue to grow.

We’ve seen for many, many years the cycle of bigger companies buying smaller companies, buying that innovation, to continue to grow. I think the FTC challenge of the Amgen-Horizon merger initially raised some questions, but that’s been resolved very quickly in favor of allowing these kinds of deals to continue to happen. We think that will continue and it’s been very beneficial for us. These acquisitions will typically happen at a 50 to 100% premium or even more. And hopefully, we can continue to find those kinds of companies that have real innovation that’s of interest to the bigger companies.

Lyons: I should have also mentioned that the large pharma companies have more than $500 billion of cash in firepower that they can use to deploy in this M&A, so we see a lot of M&A going forward as well.

Castleton: Okay. And that’s a great transition actually. We talked about biopharma being one of the more stable ballasts within the healthcare sector, to biotech which is one of the major growth engines through the amount of innovation within that sub-sector. That’s a good transition, Dan, to biotech. Biotech did have one of its worst drawdowns on record in 2021 and 2022. It has since come back, but it hasn’t had that full recovery yet. What do you think will be required to have that turnaround? And just broadly, what opportunities are you seeing within the biotech sub-sector today?

Lyons: Yes, it’s a great point. People often, I think, lose the view that innovation is happening within biotech when they look at the broader indices, which, to your point, have suffered and went through a significant drawdown recently. What we’ve seen in the sector though is really quite a contrast between what we call the haves, which are companies that have shown really dramatic innovation and have been able to raise enough capital to develop programs going forward, versus the have-nots.

During 2020, we saw a lot of new biotech company formation. In many cases, companies that didn’t really have a plan and didn’t really have a pipeline, and those companies, not surprisingly, have languished within the markets. And that is, we think, what’s leading to a lot of the broader index selling off. But this, I think, just highlights the very high importance of an actively managed strategy, which can basically harness and find the haves within the sector that are delivering on innovation. And I guess the last thing I would just highlight within this class of haves within the sector, they have access to a wide range of new modalities. I mentioned a few of them earlier. Cell and gene therapies is one example. But as the industry develops new platforms, they’re better able to meet unmet medical needs and find new therapies. That’s what we think is really driving a lot of the benefits in the innovative haves within the sector.

Acker: Yes, when we think about the biotech sector broadly, a lot of times people will look at the S&P Biotech ETF, which tracks about 600 biotech stocks. That ETF has been weak for the last few years after a very strong period in 2020. But I think you have to remember what we call the 90-90 rule, right, and the fact that 90% of drugs that begin human clinical testing will never make it all the way to market. As Dan mentioned, a lot of companies got funded in the excitement of 2020 because the industry was on the front lines of fighting COVID-19 with a lot of success.

There was a view, broadly, that just everything was going to work and be that exciting. Unfortunately, that’s not how it works in biotech. But that’s really why we have a job and a role and a career. Because to find companies that will be successful is extremely challenging, but it’s not impossible. There is incredible innovation in the sector, like nothing we’ve ever seen. A lot of the advances today would have seemed like science fiction maybe ten years ago. But you need a team that can really dig down and understand both the science and the business. Virtually every member of our therapeutics team has a Ph.D. or an M.D., and you really have to understand the details behind the science that’s driving these therapies.

But the ones that are successful can generate unbelievable value. Companies like BioNTech a few years ago had a $2 billion market cap, at one point got to be a $100 billion cap. There are these success stories in this industry that can be unlike almost any other industry. Again, it’s not easy, but you can be more often right than wrong in terms of identifying these really innovative companies that can generate a lot of value for shareholders, really, in the economic environment.

Castleton: Right. And so, I think just to tie this all up for our investors, let’s just go to where we’re at today and just highlight again the case for healthcare in general. Off the back of what you were just mentioning, we do know the growth potential within biotech. But what’s the case for healthcare, biotech, and other sub-sectors, in general, in today’s environment?

Acker: Yes, so I think we have to first of all think about where we are in terms of the economy right now and the market overall. We came into 2023 with an expectation that we were going to have a recession and then that didn’t happen. And then, we got a lot of excitement about these advances in AI, which are extremely exciting. And I think there’s a consensus view that’s built up now that we’re going to have a soft landing. We’ve seen inflation start to slow and the markets perform very well. And there’s a view, generally, I think, that maybe we’re going to avoid a recession. Not only that, but the odds of a recession are very low. And, yes, we still think there are these pressures on the economy that are very real but take time to play out, and they just haven’t fully played out yet. If we think about the inverted yield curve, which almost always predicts a recession correctly, it’s only been since November, so it hasn’t even been a year. Typically, that impact takes one to two years. We’ve had the fastest increase in interest rates since the 30s, and yet, they’ve only been at a high level for a few months. And again, that takes one to two years.

We have quantitative tightening. We have literally trillions coming out of the money supply. Also, the impact of that takes time to be felt. And finally, we have bank lending that is slowing substantially. And again, that takes time. All of these impacts take time to work their way through the economy, and we believe they’re really going to hit more in 2024 than 2023. And the economy can actually perform quite well right up until it hits a wall, as we saw during the global financial crisis. Now, the expectation for earnings, broadly, in the market is for double-digit growth in 2024, and that is not at all consistent with the potential for a recession, so we think there’s a real risk to the overall markets.

Meanwhile, we have healthcare, which this year has been hit by what I would call the pandemic hangover because we had billions of sales for vaccines and treatments and diagnostics for the pandemic, which have really come down substantially this year because we had an end to the public health crisis. Those products have come down, and that’s weighed on earnings for healthcare this year. But we’ve now sort of reset to a lower level and we think healthcare can grow broadly even during a recession. That’s typically what we see – that healthcare demand holds up much better during an economic slowdown and a recession. So, we think healthcare, which trades at a discount to the market, and risk to earnings for the broader market really puts healthcare in a very good position on a relative basis in terms of the defensive characteristics of the sector and the lower valuations. But at the same time, we have this increased innovation, which we think is not being appreciated.

And if we think about we talked about 250 drugs approved over the last five years, this year could actually be a record for new products being approved. We could have as many as 80 new medicines approved in 2023. What’s important about that is that drives growth for the industry, not just for the next couple of years, but typically the product cycle lasts for a decade or longer. And so, whether it’s new therapies for Alzheimer’s, obesity, diabetes, cancer, NASH, or fatty liver disease. There are all of these new therapies addressing high unmet medical needs that we think will drive growth for the sector for years, and even decades, that we think

currently is not being appreciated. While there are worries about drug pricing and worries about regulation, we see a sector that’s been left behind this year. And we think the setup going forward is actually quite attractive.

Castleton: That’s great. Our team talks all the time about how it is very difficult to predict exactly where the market is heading. And so, factoring in everything that’s going on within the economy, the attractiveness within healthcare, it makes a ton of sense what you just laid out in terms of the opportunities of investing in that sector today. Also, just because the themes are very investable and attractive to end users, whether it’s population growth or aging demographics. Dan, so as you just think about the implementation of your team, just how do you think about investing themes within your strategies?

Lyons: Yes, that’s a good point. And you bring up the aging demographics, which is a broad reason that people always think of in healthcare. Andy mentioned some other key factors to keep in mind, which are obviously front and center. One being innovation that we’re always looking for to harness these massive new growth markets that are just going to unfold as these products are getting FDA approval and launching in the coming years, and the really attractive valuations of the sector.

But in terms of how we take advantage of healthcare more broadly, we really focus on both the science and the business. And when we’re looking for true innovation within healthcare, we’re looking for products that can change the practice of medicine. And it’s those products that are likely to become the next blockbuster therapies that are in this ramp of new products that Andy mentioned. The 80 new drugs receiving FDA approval over the coming year. That’s really our fishing ground, I guess. It’s not easy because we always have to keep in mind the 90-90 rule, where there’s only 10% of these therapies that are going to make it through. But by really focusing on the underlying science, does it make sense? And then, thinking through the various aspects of clinical development for new therapies, we think that we can do a good job of finding these innovative therapies. That’s what gets us ultimately really excited about the healthcare sector overall going forward.

Acker: And just to clarify this. The second part of the 90-90 rule refers to the commercial expectations. What we found in more than 24 years of investing in healthcare is the consensus expectations for a new product launch are wrong 90% of the time. First, you have only 90% of the drugs will never make it. And then, for the ones that make it, expectations from Wall Street are wrong 90% of the time. We’re not going to be perfect, but we try to just be more accurate than the market at finding the companies that have underappreciated clinical and commercial potential. What we found is that can drive value in any market environment over the long term.

Castleton: Well, Dan, and Andy, thank you so much for being here today to talk about such an interesting sector. We hope our listeners today got a better understanding of some of the investment implications behind some of the different sub-sectors. Namely, how healthcare offers this great balance of offense and defense in such an uncertain environment, and how a well-diversified and active approach can be really additive to investors today.

For more information and insights from Janus Henderson, feel free to download other episodes of Global Perspectives, including a recent one from your colleague, Luyi, who talked more in-depth on just the obesity drugs and the innovation behind that sector. You can also visit our website at janushenderson.com. I’m your host for the day, Lara Castleton. Thanks. See you next time.