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Working pharm

It may not seem glamorous during these volatile equity market conditions but several managers are relying on traditional defensive plays such as healthcare to see them through.

Except these days, managers claim healthcare stocks are not quite the boring old pharma story they may have been in the past. Many such firms have reshaped themselves and today offer a heady mix of their traditional steady dividends with renewed capital growth opportunities.

It has been a rocky few months for investors and the growing euro crisis means the culmination of negative events is unlikely to end just because the summer has. Investors have been heading for “safe haven” assets, with gilts, corporate bonds and gold all seen as a place to shelter from the impending storm.

Over the six months to August 31, the best-performing areas of the market happen to be those investors have headed towards – gilts and corporate bonds. They are also the only sectors, including money market, that have made a positive return over that timeframe. Even the popular absolute sector has on average produced a fall over the past six months although at -1.47 percent, it was the weakest drop of all the other IMA sectors.

Still, despite this short-term demand for and performance of the fixed-interest areas, equity fund managers argue the apparent safety of fixed interest is just a placation in light of recent events. In reality, buying bonds at current levels may lead to capital losses.

Such managers also proclaim investors should just get accustomed to equity volatility, that it is not likely to go away any time soon.

They argue the changed reality with regards to stockmarket volatility does not negate the real value equities can offer – particularly those with an added income stream in the form of dividends. This is where healthcare and pharmaceuticals are coming into play.

Evenlode income fund manager Hugh Yarrow has around 23 per cent of his portfolio in healthcare, with Glaxo-smith-kline and Johnson & Johnson within his top 10 holdings.

Healthcare stocks have tended to disappoint over the years but Yarrow says such firms have fundamentally changed since the 2008 crisis.

Capital discipline among pharmaceuticals may have gone out the window 10 years ago but it is back and stronger than before.

Yarrow says: “Healthcare companies have had a lot of headwinds to contend with over the past 10 years, from US healthcare reforms to patent expiries and increased competition with generics. Today, there is more reason for optimism.”

Ben Peters Evenlode fund investment manager Ben Peters says many pharmas have reformed, bringing new life to areas of their businesses many thought to be dragging them down such as R&D projects. Companies such as Glaxo are expanding in the area of biologics, producing more complex drugs that are much more difficult to replicate by generic producers, he says. At the same time, Yarrow says management has become more focused, creating better value for shareholders. “It is better to own these stocks today than ever before,” he says, noting that even in light of their better return profile, they remain on attractive valuations.

Which is surprising considering their popularity in the fund management community. Glaxo, with its high dividend yield, is particularly popular for income managers. According to FE Analytics data, 13 UK equity income funds have more than 15 per cent devoted to the healthcare sector right now and over 40 portfolios in the 101-strong peer group have greater than 5 percent weightings to Glaxo alone.

The UK pharmaceutical group features among the top 10 holdings in more than 70 funds in the UK equity income sector, including the offerings from Artemis, Axa Framlington, Cazenove, Invesco Perpetual, Jupiter, Newton, Fidelity, JP Morgan, Schroders, Rathbones, Troy and Threadneedle. Psigma income manager Bill Mott pointed out in his latest factsheet that Glaxo represents his biggest overweight stock position.

Invesco Perpetual’s Neil Woodford has been particularly positive on pharmaceuticals and currently has the two biggest positions in his high-income fund in such companies – Astrazeneca at 8.37 per cent followed by Glaxo at 8.22 percent. In his latest commentary, Woodford says that despite the volatility and bad news over the summer months, company-specific news has not been so bleak, highlighting in particular healthcare.

He says: “Pharmaceuticals giant AstraZeneca raised its full-year profit forecast and pledged to return more cash to shareholders via share buy-backs but even better news for shareholders was that its heart drug, Brilinta, had been approved by the US Food and Drug Administration.”

US healthcare firm Johnson & Johnson, a long-term favourite of M&G global dividend manager Stuart Rhodes, is a good example of the long-term advantage of holding healthcare companies. Rhodes is fond of pointing out that Johnson & Johnson has one of the longest sustained track records of dividend payouts of any company across all market sectors not only in the US but also compared with the UK.

Yarrow is also a fan. In 2001, he noted Johnson & Johnson was on a rating of around 40x forward earnings while today it is around 12x. Yet through the ups and downs of its valuation, he says Johnson & Johnson has cumulatively delivered a 14 per cent a year total return since 1977 compared with 10 per cent TR from the S&P 500, he pointed out.

UK managers are not alone in the belief that healthcare has the resilience to withstand the current bleak, global economic outlook.

David Cornell, manager of the India capital growth fund run by the newly formed asset management group Ocean Dial (a part of Caledonia), is also positive on healthcare investment opportunities in his region. He says India spends the lowest amount on healthcare of any of the big emerging economies and yet forecasts predict in less than 20 years it will be home to some 30 per cent of the world’s diabetics.

It is statistics such as this that give managers confidence in the prospects of the sector and belief that such companies can thrive even in downward trending market conditions. Despite the economic austerity packages and sovereign debt woes, demographics suggest spend on healthcare will be needed – everywhere.

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