Half-year Report
20 November 2019
LONDON STOCK EXCHANGE ANNOUNCEMENT
Worldwide Healthcare Trust PLC
Unaudited Half Year Results for the six months ended
30 September 2019
This Announcement is not the Company’s Half Year Report & Accounts. It is an abridged version of the Company’s full Half Year Report & Accounts for the six months ended 30 September 2019. The full Half Year Report & Accounts, together with a copy of this announcement, will also shortly be available on the Company’s website: http://www.worldwidewh.com/ where up to date information on the Company, including daily NAV, share prices and fact sheets, can also be found.
The Company's Half Year Report & Accounts for the six months ended 30 September 2019 has been submitted to the UK Listing Authority, and will shortly be available for inspection on the National Storage Mechanism (NSM): http://www.morningstar.co.uk/uk/NSM
For further information please contact: Mark Pope, Frostrow Capital LLP 020 3008 4913.
Performance
| Six months to | One year to | ||
| 30 September | 31 March | ||
| 2019 | 2019 | ||
| Net asset value per share (total return)* # | (2.7)% | 13.7% | |
| Share price (total return)* # | (2.7)% | 14.3% | |
| Benchmark (total return)^ # | 6.0% | 21.1% | |
| 30 September | 31 March | Six months | |
| 2019 | 2019 | change | |
| Net asset value per share | 2,628.1p | 2,722.9p | (3.5)% |
| Share price | 2,635.0p | 2,730.0p | (3.5)% |
| Premium of share price to the net asset value per share* | 0.3% | 0.3% | – |
| Leverage* | 8.4% | 4.9% | – |
| Ongoing charges* | 0.9% | 0.9% | – |
| Ongoing charges (including performance fees crystalised during the period)* | 0.9% | 1.1% | – |
# Source – Morningstar.
^ Benchmark – MSCI World Health Care Index on a net total return, sterling adjusted basis. (see glossary).
* Alternative Performance Measure. Leverage calculated under the Commitment Method (See glossary).
Chairman’s Statement
PERFORMANCE
It is disappointing to report both a negative absolute return and a relative underperformance against the Benchmark in the first six months of the Company’s financial year. The Company’s net asset value and share price total returns were both ?2.7% over the period. This compares to a rise of 6.0% in the Company’s Benchmark, the MSCI World Healthcare Index, measured on a net total return, sterling adjusted basis.
Currency played a moderating role in this result, as sterling depreciated by 5.4% against the U.S. dollar over the period; the U.S. dollar being the currency in which the majority of the Company’s investments are denominated. But of course, this further underscores the extent of our underperformance in dollar terms during this time. An additional factor that should also be noted is that the level of leverage employed over the period was increased from 4.9% at 31 March 2019 to 8.4% at 30 September 2019, having previously been reduced towards the end of the previous financial year, following a period of strong performance. It was increased during this half year, to a more typical range, in response to the availability of investment opportunities.
This significant degree of underperformance relative to the Benchmark over the six months under review was primarily as a result of asset allocation within the portfolio itself. In particular, our conviction-based overweight positions in biotechnology suffered significantly during a time of market instability in which investors switched out of such stocks in favour of larger, more liquid big pharmaceutical companies, where we are relatively underrepresented.
I believe it is important to put this period of underperformance into a broader perspective. Thus, in the quarter ended 31 March 2019 the Company posted an absolute net asset value per share total return of +15.2% and an excess return of a remarkable +9.1% over the Benchmark. Then in the last 6 weeks following the end of the current accounting period, i.e. from 30 September 2019 to 15 November 2019, the Company performed strongly with an absolute net asset value per share total return of +10.5% and an excess return of +8.0% over the Benchmark. The result is that in the calendar year from 1 January to 15 November 2019 the Company has demonstrated a net asset value per share total return of +24.1%, outperforming the Benchmark by +8.9%. Unfortunately and unusually, however, this overall result contained major fluctuations of performance within it, in particular during the period of underperformance described in this report.
Our financial year to 31 March 2019 saw similar volatility in quarterly performance and overall underperformance compared to the Benchmark. However, as I write, the Company’s net asset value per share total return to 15 November 2019 is ahead of the Benchmark over one, three and five years by an estimated +4.1%, +0.5% and +4.7% respectively.
What do these unusually volatile results tell us about Worldwide Healthcare Trust and the marketplace in which it is operating? It seems clear that with the approaching U.S. Presidential election markets are becoming significantly more febrile, and that within the broader market the healthcare sector is showing a particularly high degree of sensitivity to political headlines. This is evidenced by the fact that the S&P 500 healthcare Index was a distinct laggard during the six month period, ranking tenth out of the 11 S&P 500 sectors. Indeed, healthcare was only one of two subsector constituents of the broader S&P 500 index that reported negative returns (total return in U.S. dollar terms) during this reporting period. Our Portfolio Manager also believes, as do many observers, that these instabilities are almost certainly being amplified by the significant and increasing amount of passive and algorithm-driven investing that have come to characterise stock markets in recent years.
Despite these concerns, however, OrbiMed continues to believe that the fundamentals underpinning the healthcare sector remain strong, with innovation driven growth remaining at the heart of their strategy and that their conviction-based investment approach will continue to reward investors over the long term, even though they may experience higher volatility on this journey than in the past.
Looking at specific names in the portfolio, the largest contributions during the reporting period came from medical device company Boston Scientific, biotechnology company Deciphera Pharmaceuticals and pharmaceutical company Hansoh Pharmaceutical. The largest detractors from performance were pharmaceutical company Alexion Pharmaceuticals, medical device company Wright Medical and biopharmaceutical company Puma Biotechnology. Further information regarding the Company’s investments and also the Company’s performance can be found in the Portfolio Manager’s Review.
As I have mentioned previously, the Company is able to invest up to 10% of the portfolio, at the time of acquisition, in unquoted securities. Our Portfolio Manager, through its extensive private equity research capability, has continued to identify a number of opportunities which have been added to the portfolio. Exposure to unquoted securities currently accounts for 2.1% of the portfolio.
CAPITAL
The Board continues to monitor closely the relationship between the Company’s share price and the net asset value per share. I am pleased to note that the Company’s share price has been trading close to net asset value per share for some months; as at 30 September the share price stood at a 0.3% premium to the Company’s net asset value per share. As a result, and also due to investor demand, a total of 585,000 new shares were issued at a premium to the cum income net asset value per share during the half year, raising £15.7 million of new funds. No further shares have been issued since the half-year end.
REVENUE AND DIVIDENDS
The revenue return for the period was £6.5 million, compared to £6.4 million in the same period last year. The Board has declared an unchanged interim dividend of 6.5p per share, for the year to 31 March 2020, which will be payable on 9 January 2020 to shareholders on the register of members on 22 November 2019. The associated ex-dividend date is 21 November 2019. A final dividend for the year to 31 March 2020 will be proposed to shareholders at the Company’s Annual General Meeting to be held in July 2020.
I remind shareholders that it remains the Company’s policy to pay out dividends at least to the extent required to maintain investment trust status. These dividend payments are paid out of the Company’s net revenue for the year and, in accordance with investment trust rules, only a maximum of 15% of income arising from the shares and securities making up the investment portfolio can be retained by the Company in any financial year.
It is the Board’s continuing belief that the Company’s capital should be deployed rather than paid out as dividends to achieve a particular target yield.
COMPOSITION OF THE BOARD
I am pleased to report that as part of the Board’s ongoing refreshment programme, Dr Bandhana (Bina) Rawal joined the Board on 1 November 2019. Dr Rawal, a physician with 25 years’ experience in life sciences research and development, has held senior executive roles in drug development and scientific evaluation in four global pharmaceutical companies. She also has worked in senior roles with two medical research funding organisations: Wellcome Trust and Cancer Research UK.
Dr Rawal is currently a non-executive Director of the Innovation Agency (Northwest Coast Academic Health Science Network) where she supports the adoption and spread of innovation within the NHS. She is also a Trustee of two educational charities: the Social Mobility Foundation and the Children’s University Trust and commenced her membership of the Council of St George’s University of London in October 2019, having been a member of Council at the University of Reading.
A resolution proposing Dr Rawal’s election to the Board will be put to shareholders at the Annual General Meeting of the Company to be held in July 2020.
OUTLOOK
Despite continued market volatility due, in part, to the impact of geopolitical events on market sentiment, the spectre of a global recession and also to the uncertainties surrounding the 2020 U.S. Presidential election, our Portfolio Manager continues to believe that the fundamentals underpinning healthcare equities remain strong.
Their focus remains on the selection of stocks with strong growth prospects and we reiterate our belief that the long-term investor in the healthcare sector will be well rewarded.
Sir Martin Smith
Chairman
20 November 2019
Review of Investments
MARKETS
Global equity markets for the six-month period from 1 April to 30 September 2019 proved to be surprisingly immune to the many geopolitical storms that were front and centre in the headlines during this time, from U.S. and China trade tensions, to uncertainty in the U.K. over “Brexitâ€, and to growing concerns over a worldwide economic slowdown. Volatility spikes in May and August did indeed rattle the markets with sharp pull backs in each of those months, respectively, yet equities were still able to finish the period higher.
Certainly, the world’s major central banks detected a weakening economic climate and responded accordingly with a more dovish tone and actions, such as the U.S. Federal Reserve cut in interest rates in the second quarter of the Company’s financial year, which helped buoy equities. Whilst U.S. and China trade talks drove most of the volatility in the period, investor hopes for a deal appear to remain cautiously optimistic heading into the end of 2019.
Overall, the MSCI World Index price return in the six-month period was a robust +9.3% (in sterling terms). Currency volatility was noteworthy, with sterling weakness impacting the dollar return of the index by some 540 basis points, with a price return of +3.4% in U.S. dollar terms. This compares to the FTSE 100 Index price return of +1.8% (in sterling terms) and -3.7% (in dollar terms). In the U.S., broad returns were higher, with the S&P 500 returning +11.0% (in sterling terms) and +5.0% (total return in U.S. dollar terms).
Meanwhile, healthcare equity returns, facing their own set of unique industry headwinds, were also able to post positive gains in the period, but below those of the broad global market. Specifically, the MSCI World Healthcare Index returned +6.0% (net total return in sterling terms) and +0.2% (net total return in U.S. dollar terms). Whilst most of healthcare moved higher in the period under review, two subsectors posted notable losses which weighed on the index, namely emerging biotechnology stocks and generic/specialty pharmaceutical stocks that were exposed to the U.S. opioid litigation.
PERFORMANCE
For the six-month period, the Company posted both a share price total return and a net asset value total return of -2.7%. This performance underperformed the benchmark return of +6.0%.
Despite a very strong start for performance to begin the calendar year in 2019 (with over 900 basis points of excess return from January to March 2019), recent underperformance in the six-month period was primarily due to various macro-factors impacting healthcare returns, exacerbated by our relative sub-sector positioning.
For example, healthcare experienced a tumultuous month in April after U.S. political rhetoric reared its head. Presidential hopeful Bernie Sanders (U.S. Senator for Vermont) hosted a “town hall†meeting to discuss his plan for “Medicare for Allâ€, a strategy to provide free healthcare for all American citizens. Healthcare stocks fell on fears of a potential shift to a single payer system in the U.S. The sell-off was so extreme it was as if Mr Sanders were already President and legislation was imminent. Of course, that is not the case whatsoever, and in our view, is close to a zero-probability event.
Nevertheless, healthcare stocks sold off en masse with high growth, small and mid-capitalisation names falling more than lower growth, larger capitalisation names. Further, given the Company’s relative positioning between biotechnology and pharmaceutical stocks, underperformance in the month was not to be avoided. This occurred despite our underweight position in managed care stocks, which were the most volatile in the period.
Throughout the first quarter of the Company’s financial year, additional news headlines materially impacted the generic and specialty pharmaceutical sector. The opioid addiction epidemic in the U.S. has been well chronicled and now restitution is being sought by all 50 state governments in America due to the claim that harm was brought to their respective constituents from the various manufacturers of opioid-containing pain killing medications. News flow on the magnitude of the liabilities stemming from court action, including reports of potential bankruptcy proceedings for some drug makers, weighed heavily on share prices for those involved. Share price declines ranging from -50% to -80% were typical. Whilst our portfolio exposure to the opioid litigation now rests at zero, our earlier investments here that were exposed, both directly and indirectly and both real and perceived, contributed to underperformance.
At the beginning of the second quarter of the Company’s financial year, specifically the summer months of July and August, macro related news flow on healthcare was mostly quiet. For the most part, quarterly earnings reported during this period were in-line to above expectations and performance trended in-line with the benchmark which was mostly flat.
However, the month of September, which closed out the six-month period, turned out to be historic for all the wrong reasons. One key issue that impacted the markets significantly in that month was non-fundamental price action fuelled by an epic unwind of the “momentum factorâ€. This significant event resulted in a steep sell-off in stocks that had outperformed year-to-date, coinciding with a rise in value stocks, especially equities that previously underperformed. This had a profoundly adverse effect on the Company’s performance, given our relative positioning to the benchmark, built around a clear preference of growth over value.
Finally, an idiosyncratic but distinct sell-off in biotechnology stocks, especially small and mid-capitalisation stocks, in the second half of September saw those stocks sell off nearly 900 basis points (in U.S. dollar terms) in the last two trading weeks of the month. Again, this had a particular adverse impact on the Company’s performance, given our material overweight positioning in the biotechnology sub-sectors. In summary, September’s performance contributed the majority of the year-to-date underperformance relative to the benchmark.
One other macro observation of import to note relates to biotechnology fund outflows during the six-month period. Historically, biotechnology sector fund flows have been significantly volatile over the past few years. However, we note that in the last seven consecutive weeks to end the reported period, biotechnology sector fund flows were negative. If the first week of October 2019 is included, it marked the eighth straight week of outflows, which totalled c.U.S.$3.2 billion during this time, and now represents the longest stretch of continuous outflows since early January 2016. Overall, biotechnology sector net fund outflows were approximately U.S.$7.5 billion in the period (source: Piper Jaffray & Co.).
Notable sub-sectors with outsized positive contributions to performance started with our significant investments in emerging market healthcare stocks. This is a distinct reversal from the previous financial year in which these stocks came under severe selling pressure due to the U.S./China trade war rhetoric. The evolution of the healthcare regulatory requirements in China to a more western-style standard has clearly benefitted the most innovative companies, both domestic and multi-nationals. Identifying these “blue chip†companies has been an effective part of our investment strategy. The Company has also benefitted from new initial public offering (IPO) rules in Hong Kong, which now allow non-profitable companies to become listed entities. This has allowed a burgeoning biotechnology industry to join the public equity markets, many of which were successful investments for the Company. Overall, our emerging markets exposure returned over 250 basis points of absolute and relative return.
Other sub-sectors with significant positive returns included medical technology (+200 basis points) and large capitalisation pharmaceuticals (+150 basis points).
Whilst the momentum factor unwind and severe biotechnology sell-off did adversely impact performance in September, we are pleased to report that the Company’s performance rebounded significantly in the period following the end of the half year. Specifically, the Company posted an excess net asset value per share total return of +8.0% over the Benchmark during the period from 30 September 2019 to 15 November 2019. Key drivers included a rebound in biotechnology stocks, including a number that rose following the release of positive news flow, plus stock selection in medical device and Japanese pharmaceutical stocks together with continued outperformance in emerging market stocks.
MAJOR CONTRIBUTORS TO PERFORMANCE
The top individual contributors to performance in the six-month period come from a variety of sub-sectors. A common trait? Operational execution that drove their respective share prices higher.
A prototypical example is Boston Scientific, one of the most highly diversified and innovative medical device companies. The company develops products that are used in interventional cardiology, cardiac rhythm management, peripheral interventions, electrophysiology, neurovascular intervention, endoscopy, urology, gynaecology, and neuromodulation procedures. In the period under review, its share price appreciation was driven by improved investor sentiment regarding its long-term growth prospects. More specifically, investor attention has become more keenly focused on the 10 plus acquisitions the company has made over the past 18 months. These transactions, in aggregate, should help support the company’s organic sales growth rate, which should be amongst the highest in the large capitalisation medical devices sector for the next three to five years. These acquisitions, as well as several promising internal programmes, were highlighted at the company’s biennial investor day in June 2019.
In the treatment of many cancers, the usage of targeted therapies, drugs that can distinguish between normal cells and tumour cells, has been common place now for decades. However, targeted therapies are enjoying a renaissance of sorts, with more powerful, safer, and more targeted drugs being developed. Deciphera Pharmaceuticals is a biotechnology company at the forefront of targeted therapies for cancer. The stock moved sharply higher in August after the company reported positive results from the Phase III INVICTUS study of lead asset, ripretinib, for the treatment of gastrointestinal stromal tumours (GIST), a form of soft tissue sarcoma that can be found in any part of the digestive tract. This pivotal trial showed that ripretinib reduced the risk of disease progression by an astounding 85% compared to the placebo in patients who had previously failed at least four other treatment regimens. Importantly, the safety profile appeared favourable compared with other drugs targeting this patient population.
Hong Kong-based Hansoh Pharmaceutical is one of the largest drug innovators in China and focuses on four distinct therapeutic areas: central nervous system; oncology; anti-infectives; and diabetes. The company’s current revenue is mainly from a group of branded generics with number one or two market share in China, including Oulanning (olanzapine), Pulaile (pemetrexed), Zefei (gemcitabine) and Xinwei (imatinib). Its major late-stage innovative clinical assets include a third-generation targeted therapy for lung cancer and long-acting GLP-1 agonist for the treatment of Type II Diabetes. Given our overall bullish view, we participated in the company’s Hong Kong IPO in June 2019. Since then, the shares have traded extremely well, up over 70% (in Hong Kong dollars), given the company’s dominant leadership in research and development and operational excellence among China large capitalisation pharmaceutical companies.
California-based, Natera, is a diagnostics company that is an industry leader in non-invasive prenatal testing (NIPT) and other genetic testing. The share price was very strong over the past six months as the company’s core NIPT business demonstrated continued strong volume growth. Additionally, commercial traction increased among biopharmaceutical customers for its “Signatera†liquid biopsy oncology test. However, perhaps most important, the company reported several positive updates, both in its clinical pipeline and business development efforts. This included multiple Medicare coverage approvals for proprietary diagnostic tests and an announced partnership with Foundation Medicine, a Roche-owned company, to collaborate on additional cancer related tests for “Signateraâ€.
Edwards Lifesciences is a developer of tissue replacement heart valves, and more specifically transcatheter heart valves (THV). The company’s aortic THV portfolio has been on the market for some time, but until recently was only approved in the United States for patients deemed intermediate-to-high-risk for open heart surgery. However, the company has been successful in expanding the approved usage of THV into low-risk patients as well after the company presented superior data at a major medical congress in March 2019. The strong data has helped drive a sizable reacceleration in THV market growth, and thus a positive re-rating of the stock as investors expect continued THV market acceleration in the second half of 2019.
MAJOR DETRACTORS FROM PERFORMANCE
Notable detractors from performance in the period were largely biotechnology companies that experienced some negative news flow but were prone to excessive sell-offs given the macro environment that created a material head wind for high risk, high growth stocks.
Alexion Pharmaceuticals, specialises in the discovery and development of drugs used to treat rare diseases. The company’s lead product Soliris (eculizumab) is a monoclonal antibody approved to treat paroxysmal nocturnal haemoglobinuria (PNH), haemolytic anaemia, neuromyelitis optica (NMO), and myasthenia gravis (MG). Shares in the company pulled back over the period due to investor fears over the strength of the company’s U.S. and European patents protecting Soliris. Emerging competition from other biotechnology companies developing therapies in PNH, NMO, and MG have also weighed on the shares. The company is in the process of launching Ultomiris, a second-generation complement inhibitor with a much better dosing profile (every eight weeks rather than every two weeks for Soliris) that has much longer patent protection. Like many of the other large capitalisation biotechnology stocks, Alexion’s valuation has contracted due to uncertainty about the drug pricing climate generally as well as concerns about the sustainability of the company’s growth.
Wright Medical is a Dutch domiciled company whose business is conducted predominantly in the U.S. It develops joint replacement devices, primarily for shoulder, foot & ankle, trauma & sports medicine procedures, as well as ortho-biologic products. After a long string of positive quarterly updates, the company stumbled during the second quarter of 2019. A combination of heightened distributor turnover in a key new business segment, and sales personnel losses in the company’s lower extremity sales force drove results below consensus expectations and led to a downward revision to 2019 guidance. Given strong positive signals from management during the first half of the calendar year, investor concern about management credibility also spiked following the weaker second quarter results, leading to an even more pronounced downward move in the shares.
California-based, Puma Biotechnology, has been in the forefront in the ongoing battle against breast cancer. The company markets the tyrosine kinase inhibitor Nerlynx (neratinib) for early-stage breast cancer. Shares declined over the period due to disappointing quarterly sales results announced in May that came in well below consensus expectations. While the theoretical peak sales potential for the drug are high, the drug’s high rate of side effects has adversely impacted physician and patient adoption. We exited the position due to doubts about the company’s ability to execute and grow revenues to allow the company to reach profitability.
One of the largest mergers and acquisitions (M&A) healthcare transactions in the past decade closed in January 2019 and the start of the “newco†experienced some unexpected volatility. The acquisition of Shire by Takeda Pharmaceutical had been fraught with many uncertainties, from timelines, to synergies, to flowback, to earnings. As a result, the stock sold off significantly in 2018, signalling our entry point. The stock rallied to start the calendar year after the earlier than expected closing date in January. However, the share price subsequently faded after the company announced underwhelming guidance for the 2019 fiscal year. We remain optimistic that the company, at the current valuation, is a materially mispriced asset.
Regeneron Pharmaceuticals, is a large-capitalisation biotechnology company specialising in antibody-based therapeutics. The company’s lead drug is Eylea (aflibercept), a recombinant protein injected directly into patients’ eyes to treat wet age-related macular degeneration, a leading cause of blindness in the elderly. The company also markets a number of antibodies through a joint venture with Sanofi Pharmaceuticals, including Dupixent (dupilumab), a treatment for atopic dermatitis and asthma, and Praluent (alirocumab), a treatment for high cholesterol. Regeneron’s shares pulled back over the period due to increasing concerns about competition to its lead product Eylea. In addition, investor fears have persisted about the potential implementation of an International Pricing Index (IPI) proposal from the Trump administration, which would link prices paid for certain Medicare drugs to a basket of prices for the same drugs found in European countries. Such a proposal, if implemented, would have a negative impact on Eylea pricing in the U.S.
SECTOR DEVELOPMENTS
Overwhelmingly so, the overall fundamentals of the healthcare industry remain positive. The secular tailwind is as strong as ever, from more people (from global population demographics), more innovation (from unparalleled technological advancements), more drugs (from record number of approvals), and more money (from increasing gross domestic spend on healthcare). Simply put, the demand for healthcare continues to rise on a global basis.
Undeniably, we remain at a peak era of innovation in the biopharma industry. The genomic revolution at the turn of the century is now ripe enough to be producing more treatable targets than ever before. Drug development is more sophisticated and has resulted in less attrition in later stages than previously seen, and the number of platform technologies continues to expand. Gene therapy, cell therapy, next generation targeted therapy, immunotherapy, antibody drug conjugates, bispecific antibodies, and novel small molecule receptor/ligand science are just some of ways in which unmet medical needs are being satisfied using today’s modern medicine.
The U.S. Food and Drug Administration (FDA) has just had another record year for new drug approvals. 2018 marked the second consecutive year in which the Agency has approved a record number of new molecular (or biological) entities, with 59, smashing the 2017 record of 46. Also of note, the Agency approved a record number of generic drugs in 2018, eclipsing the newly set record in 2017. As of the end of September 2019, the run rate for expected approvals in 2019 was 47 (source: Washington Analysis). Whilst a third straight record setting year seems unlikely, it is clear that new product flow in the industry is at unprecedented levels.
The unexpected resignation of FDA Commissioner Scott Gottlieb in early 2019 was disappointing. Health and Human Services named Ned Sharpless, head of the National Cancer Institute, the acting Commissioner in April 2019. Already an appointee of President Trump and vetted by Congress, we believed Dr. Sharpless was the leading candidate to become the next head of the FDA. However, news reports out of Washington D.C. in early October 2019 suggested that President Trump may nominate oncologist Dr. Stephen Hahn, who currently serves as the chief medical executive at MD Anderson Cancer Center in Houston, Texas. Regardless, the FDA has established unprecedented levels of efficiency, modernisation, and collaboration and has never been more aligned with the bio-pharma industry to get new drugs approved. We expect the career staffers to carry on this current culture of achievement, regardless of who may become the next commissioner.
M&A remains a constant theme for healthcare stocks. Whilst the exact pace may ebb and flow due to a variety of factors, the continued take-out of small and mid-capitalisation biotechnology stocks by their large capitalisation bio-pharmaceutical peers continued in 2019. Whilst the IPO and secondary market has been “hot†in 2018 and 2019, we have continued to see these deals. Most recently, 2019 has been witness to the return of the “mega mergerâ€, with the close of Takeda Pharmaceutical’s acquisition of Shire and the announcements of the Bristol-Myers Squibb merger with Celgene and Abbvie’s similar announcement with Allergan.
The main and perhaps the only headwind in the sector today has been purely political in nature. President Trump’s unexpected U.S. Presidential election victory in November 2016 temporarily muted the rhetoric around U.S. drug price reform, originally catalysed by Democratic Presidential nominee, Hillary Clinton, in a September 2015 tweet about drug “price gougingâ€. Rather, the President initially focused on continued motivation to increase competition to lower drug prices via market forces, through innovation (a positive surprise) and more drug approvals. But after an 18-month respite, President Trump has resumed the drug price rhetoric and 2019 has brought an inflection point around the topic as yet another Presidential election cycle is upon us some 12 months ahead of the November 2020 vote.
Whilst a host of proposals have been tabled on how to curtail out-of-pocket expenses for seniors in America, including those that may dramatically impact how drugs are priced in the U.S., we do not expect any legislation to be passed ahead of the next election. Timelines and partisan politics will almost surely scuttle any notable legislation. In fact, given the powerful PhRMA lobby and the likelihood of a continued split Congress post the election, we expect the status-quo even post-election.
STRATEGY REVIEW
The Company’s objective remains unchanged: to achieve a high level of capital growth through investment worldwide in a diversified portfolio of shares in pharmaceutical and biotechnology companies and related securities in the healthcare sector. As productivity and innovation rise, the number of investable ideas also rises, but the scrutiny and diligence required to isolate them becomes more complex.
Biotechnology
Sentiment regarding major biotechnology has remained tepid throughout the six-months ended 30 September 2019 as expectations for slowing growth and the perceived competitive challenges to the companies’ core franchises have persisted. Concerns over future competition from biosimilars as well as other innovative drugs continue to weigh on share prices, as there is significant uncertainty about how some of the competitive markets will unfold.
Layered on top of the slowing growth outlook for large capitalisation biotechnology has been the overhang of drug pricing rhetoric during the U.S. Presidential election campaign season. Both President Trump and the Democratic Presidential nominee candidates have talked publicly about wanting to reduce drug prices in the U.S., and the rhetoric continues to cast a cloud over the sector. As of the time of this writing, Elizabeth Warren, one of the more progressive Democratic Presidential candidates, has been gaining in the polls for the Democratic nomination versus former Vice President Joe Biden, who is regarded as more centrist in his outlook. Warren is viewed as more antagonistic to the drug industry compared to Biden, and her ascendance in the polls led to increased share weakness in the biotechnology sector towards the end of the review period. From a valuation perspective, major biotechnology companies continue to trade at historically low price to earnings ratios, many in the single digits, with share prices already discounting most of the fears over slowing growth, competition, and the future macro drug pricing outlook.
Our view continues to be that no matter which Presidential candidate is elected, a split Congress post-2020 with the Republicans maintaining control of the Senate and Democrats maintaining control of the House, will effectively prevent any egregious drug pricing legislation from passing. There remains some chance that President Trump and Congress will manage to enact an incremental drug pricing bill prior to the election, which would hopefully clear the drug pricing overhang for the sector. Historically, when political overhangs on drug pricing have cleared, the sector has re-rated upwards in a “relief rally.â€
While it’s commonly acknowledged that major biotechnology will need to engage in M&A to improve their growth prospects, the amount of M&A consummated during the period has been disappointing. Possible reasons for the relative lack of M&A include continued uncertainty about the drug pricing environment in the U.S., inability to reliably predict future cash flows for assets in competitive disease areas, and a healthy financing environment for smaller biotechnology companies, which diminishes their need to sell to larger companies. We continue to believe that M&A activity by large capitalisation biotechnology companies, either as acquirors or as targets, should lead to an upward inflection in share prices from the current depressed levels.
As the global leaders in innovation, the fundamentals of the emerging biotechnology sector remain positive, yet recent stock performance has been weak, which we attribute to political uncertainty in the drug price debate. In particular, investor interest has been high for novel targeted therapies for cancer. These new drugs seek to target molecular pathways which are dysregulated in cancer and are personalised based on mutations identified in patients’ tumours. The recent acquisitions of targeted therapy companies, Array Biopharma and Loxo Oncology, at significant premiums also show that large capitalisation pharmaceutical companies recognise a significant opportunity for this therapeutic class. We expect targeted therapies to continue to transform cancer treatment as more mutations driving cancer growth are identified and biotechnology and pharmaceutical companies generate drugs that specifically block these novel targets. We remain enthusiastic about portfolio companies involved in this space, which include Mirati Therapeutics, Turning Point Therapeutics, and Deciphera Pharmaceuticals.
Pharmaceuticals
Like their larger biotechnology brethren above, large capitalisation pharmaceutical stocks were impacted by the political rhetoric around healthcare reform and U.S. drug pricing. However, that is where the similarities end, and divergence begins.
Performance for U.S.-based versus E.U.-based pharmaceuticals has been disparate in 2019. For the most part, the American domiciled companies have all traded down in the calendar year. The lone exception has been Merck, given the continued impressive market share gains and new indications that their lead oncology asset, Keytruda (pembrolizumab), has obtained. Otherwise, large business development deals by Abbvie, Bristol-Myers Squibb, and Pfizer have all met with investor disappointment and share price sell offs. Even Johnson & Johnson has not been immune, with a troika of product liability lawsuits (baby powder, opioids, and Risperdal) overhanging the stock.
Meanwhile in Europe, double-digit share price gains have been the norm. Investors have sought refuge in these stocks in a classic defence strategy from several issues, including (1) Brexit uncertainty (increasing buying activity in both AstraZeneca and GSK), (2) risk-off mentality (increasing buying activity in Sanofi), (3) lowering interest rate environment, (4) growing fears of recession, and (5) U.S. drug pricing risk.
Overall, we regard the sector as being on solid footing as we remain at or near the high end of the current innovation cycle. New product flow and pipelines are generally strong. But the cradle of innovation does not rest within large capitalisation pharmaceutical companies. That is still the domain of emerging biotechnology companies domiciled mainly in the United States. Hence, M&A must be a key mandate for these companies going forward, creating a partial air of uncertainty about the state of business development within large conglomerates and their ability to adjudicate about “the next big thing†within an environment that does not reward risk taking. Hence, we remain selective in the large capitalisation pharmaceutical space.
Elsewhere in pharmaceuticals, the performance of U.S.-focused specialty and generic pharmaceutical stocks was mixed during the period with significant disparity between winners and losers. In general, specialty pharmaceutical stocks outperformed generic pharmaceutical stocks, as the former group benefited from notable new product launches, favourable pipeline disclosures and lower financial leverage. The outlook for many specialty pharmaceutical stocks is quite bright, and we believe new launch cycles and impactful business development will keep investors’ interest elevated and potentially drive multiple expansion for the group over time.
In stark contrast, generic pharmaceutical stocks remain plagued by significant legal overhangs, including opioid and pricing collusion litigation, that have significantly hampered performance. These issues, combined with relatively high debt burdens, have shaped our view that many stocks in the generic pharmaceutical group are effectively “uninvestable,†at least in the near-term. That said, with such severely depressed valuations, we recognise the potential for volatile stock re?ratings for certain names in response to positive news flow, so we continue to monitor this group closely.
Medical Technology and Devices
Fundamentals overall in the medical technology and devices sector have remained favourable, in keeping with a trend that has persisted for the past five plus years and one we see continuing in the near- to intermediate-term, if not longer. The sector continues to benefit from favourable macroeconomic dynamics in the United States as evidenced by elevated consumer confidence levels and depressed unemployment levels, ongoing strong investment in research and development pipelines, and a more accommodative FDA. Moreover, medical device companies have been largely insulated from many of the political issues facing other healthcare sectors, such as drug pricing debates and “Medicare for All†rhetoric from several Democratic Presidential primary race candidates.
From a valuation perspective, we recognise that the group currently trades toward the higher end of its historical ranges, both on an absolute basis and relative to the S&P 500 index. Nevertheless, we believe that the valuation is warranted given the consistent mid- to high-single digit organic sales growth rates and low to mid-teens earnings per share growth rates posted by the large capitalisation medical device companies. This represents the best growth the sector has seen in more than a decade, and is very favourable when compared to other companies across the S&P 500 index.
Turning to stock selection, our favourite areas of innovation and growth are in the cardiology and diabetes markets. In cardiology, we are keenly focused on the transcatheter aortic heart valve market where strong data from several companies in the space have served to drive a reacceleration in overall market penetration rates. We see this trend continuing. In diabetes, we expect several exciting new product launches to fuel elevated growth rates for years to come. Other areas of interest include surgical robotics, single use endoscopes and transcatheter mitral heart valves where we see the potential for robust innovation to drive changes in treatment paradigms in very large existing markets.
Life Science Tools and Services
The share price performance of the life science tools and services sector has been strong year-to-date as the group has shown relatively stable, albeit moderating, topline growth and insulation to several key policy debates across the healthcare landscape such as drug pricing and “Medicare for Allâ€. Even still, puts and takes around moderating macro indicators and China tariffs have been key overhangs to navigate. To that end, after a largely uneventful first quarter, second quarter earnings were more difficult as organic growth slowed against increasingly difficult comparisons from 2018, stoking concerns that the softer economy and China trade rhetoric is beginning to have an impact on fundamentals.
Whilst valuations are still towards the high end of the historical band, we believe the sector is in the midst of a “proving?out†period that results can be more insulated to macro dynamics than years past. Therefore, we believe the main question moving forward is whether organic growth and profitability can remain sustainably more resilient in the face of a macroeconomic deceleration and China trade rhetoric. While the inflection in organic growth in 2018 is likely to prove a “high-water-mark,†we believe companies across the sector have line of sight to sustained mid-single-digit growth.
To be clear, we believe there is still an element of cyclicality to the business. However, the sector is broadly less sensitive to capital equipment spending and more reliant on higher visibility ongoing services/consumables revenue streams than in years past. From an exposure perspective, there has been a broad-based effort to allocate resources towards secular growth opportunities, most notably supporting the robust innovation and activity in the biopharmaceutical space, which we view as the most durable and defensible end market. With regard to China, growth in the region has remained strong despite trade and tariff concerns as these stocks benefit from having differentiated solutions from secular investments by the government in biopharmaceutical research and development (R&D) as well as air, water, and food quality.
With regard to stock selection, we are most bullish on companies best positioned to capitalise on secular trends in the biopharmaceutical space in favour of those that carry more cyclical exposure and reliance on more mature capital equipment categories. The two bellwether companies, Thermo Fisher Scientific and Danaher Corporation, have been the most effective in positioning for these trends with the largest exposures to biotechnology industry and should continue to reap the gains of their focus on innovation and scale-up in manufacturing capacity. We see robust funding for emerging biopharmaceutical technologies and healthy increases in the development pipeline as supportive of this thesis and provide the cleanest runway for continued strong fundamental results.
Healthcare Services
The environment for healthcare services companies has remained incredibly volatile as the spectre of the 2020 U.S. Presidential election weighs heavily over the sector, with anxiety building to the point where a simple “round of applause†at a Bernie Sanders town hall event on Fox News precipitated a 20% selloff in managed care stocks in April.
More recently, the perception has grown that managed care performance has become inversely correlated with Elizabeth Warren’s rise in the Democratic primary polls, and the perceived increased risk of “Medicare For All†legislation that would eliminate the private insurance industry in the United States, making the investing environment for managed care quite difficult.
Worse, fundamentals in managed care showed signs of weakness in the second quarter of 2019, with many companies showing higher benefit costs. Other areas of healthcare services offer little reprieve from controversy, with hospitals demonstrating strangely uneven performance, distributors mired in opioid litigation, and pharmacies showing little signs of improvement in combating reimbursement and retail headwinds.
Looking ahead to the remainder of 2019 and 2020, we remain underweight healthcare services, acknowledging the difficult environment for the sector. We believe managed care stocks are materially undervalued, with a view that the eventual winner of the 2020 election will not eliminate private insurance, and instead may expand health insurance coverage or otherwise improve access to coverage, which would be positive for the industry.
We see many theoretical opportunities for the sector to re-rate higher, including: Joe Biden winning the Democratic primary, Elizabeth Warren shifting to support less disruptive healthcare policies after winning the Democratic primary, a Trump re-election, or the election of any Democratic candidate without a Democratic majority in both chambers of Congress. We believe concerns over heightened benefit costs are overblown and expect sentiment to improve off of its current low. However, we acknowledge that many investors will remain fearful until “Medicare For All†uncertainties are definitively resolved and take a long-term view.
Whilst we see election risk excessively priced into managed care, we believe election risk is underappreciated in hospitals, where a shift to lower Medicare reimbursement rates would be problematic, and are also not optimistic on fundamentals. In the supply chain, distributors lack visibility into timing and magnitude of resolution of opioid litigation, and pharmacies face headwinds that will take years to resolve. Additionally, possible legislation or administrative action on drug pricing reform could have negative implications for both sectors. In the meantime, we are positive on smaller companies with idiosyncratic opportunities to succeed, such as eHealth, a broker for Medicare insurance plans that we believe is poised for material growth ahead.
Emerging Markets
Whilst volatility was the hallmark of the Chinese pharmaceutical sector in 2018, it has rebounded very well year-to-date. It has taken some time and education, but the market has come to realise that the new government-led group drug purchasing programme has had variable impacts on different companies. For example, the impact on the larger pharmaceutical players with innovative pipelines and strong commercialisation is not a negative and is perhaps even a positive. These leading companies will continue to gain market share from small-and-medium sized companies.
The healthcare services sector in China has also performed well, owing to the increased R&D expenditure on innovative drugs and rising domestic demands for private healthcare services in the region.
In addition, we have been active in newly allowed biotechnology initial-public-offerings in Hong Kong. In our due diligence, we assign significant value to the quality of management and conduct comprehensive analysis on clinical pipelines. We believe there will be an increasing number of pre-revenue companies seeking an IPO in Hong Kong and mainland China.
Also in the period, Beijing officially launched its new technology innovation board. The “STAR Market†board is widely regarded as China’s own “NASDAQâ€. The notion is to encourage investment in domestic technology innovators, ensuring these companies have resources to develop and have an incentive to list on an onshore market.
In India, we prefer companies where the new generic launch momentum can mitigate the pricing erosion seen in the U.S. generics markets. We focus on the compliance history of a company and any upcoming major FDA inspections when evaluating an investment decision. We also prefer revenue diversity, especially from domestic (India) markets and other emerging markets, that adds to earnings stability and growth. We see increasing challenges faced by Indian generic companies on their U.S. business and selectively hold a negative view on those stocks. A few such challenges include regulatory issues related to FDA inspections, and declining profitability in U.S. business led by higher generic competition, increasing expenditure in R&D and rising cost of compliance.
We also look at investing in domestic (Indian) healthcare companies such as leading pan-India private hospitals chains having scalable and profitable business models. We continue to keep a keen eye on changing pricing dynamics, cost efficiencies, leverage and are intensely focused on the cash generating abilities of our portfolio companies.
Geographically speaking, we would highlight an important increase in our exposure to emerging markets on a year-over-year basis, with nearly a doubling of exposure there, particularly in China. The reasons for the increase are a result of an accumulation of factors. First, we note that the regulatory environment for new drug approvals in China has shifted to a more stringent, “Western†style approach with new rigorous clinical testing requirements. This favours the more highly innovative companies, both foreign and domestic, that we prefer to own. Second, the regulatory requirements for new equity listings has also changed, with companies no longer needing specific revenue and profit requirements before being eligible for IPO’s. This has allowed for an increasing number of biotechnology IPOs there, in a number of which we have participated. Third, given the uncertain U.S. political backdrop, we felt it was appropriate to decrease exposure to equities that may be more exposed, either real or perceived, to the volatility that may follow the headlines on U.S. drug pricing and/or changes to Medicare.
OUTLOOK FOR 2020
The fundamentals underpinning healthcare equities remain strong. Technology and innovation have never been more prevalent across sub-sectors, but especially in therapeutics, medical devices, and life science tools companies. With a strong secular tailwind with increases in population and patient demographics, demand for healthcare will continue to rise. Overall valuations remain reasonable and undemanding.
Global macroeconomic data remain in flux and recessionary fears are on the rise. Markets may turn defensive and global fixed income may gain a bid at the expense of equities. However, healthcare equities may offer a respite for those needing to maintain equity exposure. Of course, news flow on trade, especially between U.S. and China, could have an outsized impact on market sentiment.
2020 will bring another U.S. Presidential election. Current polling results make the outcome “too tough to call†currently but we are sanguine about the outcome. A re-election of President Trump most likely results in status quo from a drug pricing perspective as the tenor of his healthcare policy has become more patient-focused than industry bashing. A win for the Democratic nominee could also result in status-quo for federal healthcare policy. Former Vice President Joe Biden would certainly look to maintain and bolster the Affordable Care Act, a signature piece of legislation he and President Obama passed in 2010. More left-leaning Democratic candidates such as Elizabeth Warren and Bernie Sanders would have a very difficult, if not impossible, time in trying to pass legislation that would result in a material change to U.S. drug pricing without the full support of both divisions of Congress, which we would not expect. Overall, we would welcome any legislation that reduces out-of-pocket expenses for patients and increase their access to prescription medicines at the same time while protecting the innovation that stems from a free market system.
Lastly, innovation-driven growth remains at the forefront of our bullish view of the healthcare sector. The current new product cycle across the industry is clearly the best we have witnessed, with approvals of new medicines at all time highs. And the medicines of today are clearly superior to those of the past, with new standards of care being approved across a wide range of therapeutic categories. Overall, we expect many alpha generating opportunities to exist as this golden age of innovation continues.
Sven H. Borho and Trevor M. Polischuk
OrbiMed Capital LLC
Portfolio Manager
20 November 2019
PRINCIPAL CONTRIBUTORS TO AND DETRACTORS FROM NET ASSET VALUE PERFORMANCE
For the six months to 30 September 2019
| Contribution | Contribution | |
| Top Five Contributors | £’000 | per share (p)* |
| Boston Scientific | 12,119 | 0.23 |
| Deciphera Pharmaceuticals | 11,293 | 0.21 |
| Hansoh Pharmaceutical | 10,383 | 0.20 |
| Natera | 10,228 | 0.19 |
| Edwards Lifesciences | 9,220 | 0.17 |
| 53,243 | 1.0 | |
| Top Five Detractors | ||
| Regeneron Pharmaceuticals | (10,001) | (0.19) |
| Takeda Pharmaceutical | (11,985) | (0.23) |
| Puma Biotechnology†| (13,869) | (0.26) |
| Wright Medical | (14,637) | (0.28) |
| Alexion Pharmaceuticals | (17,946) | (0.34) |
| (68,438) | (1.3) |
* based on 52,981,480 shares being the weighted average number of shares in issue during the six months ended 30 September 2019.
†not held in the portfolio as at 30 September 2019.
Source: Frostrow Capital LLP
Portfolio
as at 30 September 2019
| Market value | % of | ||
| Investments | Country/region | £’000 | investments |
| Takeda Pharmaceutical* | Japan | 135,281 | 9.6 |
| Boston Scientific | USA | 89,658 | 6.3 |
| Merck | USA | 79,170 | 5.6 |
| Novo Nordisk** | Denmark | 57,467 | 4.1 |
| Alexion Pharmaceuticals | USA | 57,347 | 4.1 |
| Novartis | Switzerland | 49,683 | 3.5 |
| Edwards Lifesciences | USA | 49,539 | 3.5 |
| Intuitive Surgical | USA | 43,643 | 3.1 |
| Abbott Laboratories | USA | 42,651 | 3.0 |
| Neurocrine Biosciences | USA | 42,527 | 3.0 |
| Top 10 investments | 646,966 | 45.8 | |
| Vertex Pharmaceuticals | USA | 40,949 | 2.9 |
| Thermo Fisher Scientific | USA | 39,920 | 2.8 |
| Anthem | USA | 33,831 | 2.4 |
| Wright Medical | USA | 32,514 | 2.3 |
| Chugai Pharmaceutical | Japan | 30,116 | 2.1 |
| Natera | USA | 27,418 | 1.9 |
| DexCom | USA | 25,554 | 1.8 |
| Bausch Health | Canada | 25,462 | 1.8 |
| Regeneron Pharmaceuticals | USA | 25,439 | 1.8 |
| PTC Therapeutics | USA | 25,065 | 1.8 |
| Top 20 investments | 953,234 | 67.4 | |
| Jinxin Fertility Group | China | 25,047 | 1.8 |
| Hansoh Pharmaceutical | Hong Kong | 24,564 | 1.7 |
| CanSino Biologics | China | 23,843 | 1.7 |
| Sino Biopharmaceutical | China | 23,618 | 1.7 |
| eHealth | USA | 21,635 | 1.5 |
| IQVIA Holdings | USA | 21,208 | 1.5 |
| Deciphera Pharmaceuticals | USA | 20,994 | 1.5 |
| Cigna | USA | 19,914 | 1.4 |
| Humana | USA | 19,870 | 1.4 |
| Frontage Holdings | USA | 17,974 | 1.3 |
| Top 30 investments | 1,171,901 | 82.9 |
* includes Takeda Pharmaceutical ADR equating to 0.3% of investments.
** includes Novo Nordisk ADR equating to 1.0% of investments.
| Market value | % of | |||
| Investments | Country/region | £’000 | investments | |
| Sarepta Therapeutics | USA | 17,927 | 1.3 | |
| Exelixis | USA | 17,308 | 1.2 | |
| Tandem Diabetes Care | USA | 15,584 | 1.1 | |
| uniQure | Netherlands | 14,383 | 1.0 | |
| MyoKardia | USA | 13,260 | 0.9 | |
| Turning Point Therapeutics | USA | 12,861 | 0.9 | |
| Ultragenyx Pharmaceutical | USA | 12,421 | 0.9 | |
| Harpoon Therapeutics | USA | 11,956 | 0.8 | |
| Mirati Therapeutics | USA | 10,895 | 0.8 | |
| ArQule | USA | 9,799 | 0.7 | |
| Top 40 investments | 1,308,295 | 92.5 | ||
| MeiraGTx Holdings | USA | 9,620 | 0.7 | |
| Ascendis Pharma | Denmark | 9,497 | 0.7 | |
| Alcon | Switzerland | 8,221 | 0.6 | |
| Passage Bio (unquoted) | USA | 8,115 | 0.6 | |
| Prothena | Ireland | 7,851 | 0.5 | |
| Alliance Healthcare Services | ||||
| 2FRN 20/04/2024 (unquoted) | USA | 7,729 | 0.5 | |
| Spark Therapeutics | USA | 6,485 | 0.5 | |
| Bioventus FRN 21/11/2021 (unquoted) | USA | 6,076 | 0.4 | |
| Personalis | USA | 5,760 | 0.4 | |
| Adverum Biotechnologies | USA | 5,256 | 0.4 | |
| Top 50 investments | 1,382,905 | 97.8 | ||
| Alphamab Oncology (unquoted) | China | 4,869 | 0.3 | |
| RA Pharmaceuticals | USA | 2,869 | 0.2 | |
| Athenex | USA | 2,615 | 0.2 | |
| Medical Depot Holdings FRN 21/12/2023 (unquoted) | USA | 2,572 | 0.2 | |
| CRISPR Therapeutics | Switzerland | 2,397 | 0.2 | |
| Wenzhou Kangning Hospital | China | 1,966 | 0.1 | |
| Peloton Therapeutics (DCC* – unquoted) | USA | 487 | 0.0 | |
| Innoviva FRN 18/08/2022 (unquoted) | USA | 90 | 0.0 | |
| Total equities and fixed interest investments | 1,400,770 | 99.0 | ||
| OTC Equity Swaps – Financed | ||||
| JPM China HC A-Share (Basket) | China | 39,095 | 2.8 | |
| Jiangsu Hengrui Medicine | China | 21,956 | 1.5 | |
| Aier Eye Hospital Group | China | 20,740 | 1.5 | |
| Apollo Hospitals | India | 17,508 | 1.2 | |
| Aurobindo Pharma | India | 11,228 | 0.8 | |
| Caregen Co Ltd | South Korea | 80 | 0.0 | |
| Less: Gross exposure on financed swaps | (97,771) | (6.9) | ||
| Total OTC Swaps | 12,836 | 0.9 | ||
| Total investments including OTC Swaps | 1,413,606 | 99.9 | ||
| Put Options (Long) | 1,023 | 0.1 | ||
| Put Options (Short) | (542) | 0.0 | ||
| Call Options (Long) | 167 | 0.0 | ||
| Total investments including OTC Swaps and Options | 1,414,254 | 100.0 |
See note 1 for further details in relation to the OTC Swaps and Options.
* DCC = deferred contingent consideration.
Interim Management Report
PRINCIPAL RISKS AND UNCERTAINTIES
The principal risks and uncertainties associated with the Company are set out on pages 25 to 27 of the Annual Report & Accounts for the year ended 31 March 2019, which is published on the Company’s website. Such risks and uncertainties are as applicable for the remaining six months of the Company’s financial year as they have been for the period under review. The risks can be summarised under the following headings: Investment (including leverage risks); Operational (including financial, corporate governance, accounting, legal, cyber security and regulatory risks); and, Strategic (including shareholder relations and share price performance).
The Board acknowledges the continued uncertainty surrounding the UK’s decision to leave the EU. While the Board does not consider that this decision has significantly altered the risk profile of the Company as the vast majority of the Company’s investments are based outside the EU, it acknowledges that there has been a considerable level of currency volatility since the decision was taken. The Company does not currently hedge its currency exposure.
RELATED PARTY TRANSACTIONS
During the first six months of the current financial year no material transactions with related parties have taken place which have affected the financial position or the performance of the Company during the period.
GOING CONCERN
The Directors believe, having considered the Company’s investment objectives, risk management policies, capital management policies and procedures, nature of the portfolio and expenditure projections, that the Company has adequate resources, an appropriate financial structure and suitable management arrangements in place to continue in operational existence for the foreseeable future and, more specifically, that there are no material uncertainties relating to the Company that would prevent its ability to continue in such operational existence for at least twelve months from the date of the approval of this half yearly financial report. For these reasons, they consider there is reasonable evidence to continue to adopt the going concern basis in preparing the accounts.
DIRECTORS’ RESPONSIBILITIES
The Board of Directors confirms that, to the best of its knowledge:
- the condensed set of financial statements contained within the Half Year Report has been prepared in accordance with Financial Reporting Standard 104 (Interim Financial Reporting); and
- the interim management report includes a fair review of the information required by:
- DTR 4.2.7R of the Disclosure Guidance and Transparency Rules, being an indication of important events that have occurred during the first six months of the financial year and their impact on the condensed set of financial statements; and a description of the principal risks and uncertainties for the remaining six months of the year; and
- DTR 4.2.8R of the Disclosure Guidance and Transparency Rules, being related party transactions that have taken place in the first six months of the current financial year and that have materially affected the financial position or performance of the entity during that period; and any changes in the related party transactions described in the last annual report that could do so.
The Half Year Report has not been reviewed or audited by the Company’s auditors.
For and on behalf of the Board
Sir Martin Smith
Chairman
20 November 2019
Income Statement
for the six months ended 30 September 2019
| (Unaudited) Six months ended 30 September 2019 |
(Unaudited) Six months ended 30 September 2018 |
|||||
| Revenue | Capital | Revenue | Capital | |||
| Return | Return | Total | Return | Return | Total | |
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |
| (Losses)/gains on investments | – | (39,853) | (39,853) | – | 238,502 | 238,502 |
| Foreign exchange losses | – | (99) | (99) | – | (4,766) | (4,766) |
| Income from investments (note 2) | 8,108 | – | 8,108 | 8,141 | – | 8,141 |
| AIFM, portfolio management, and performance fees (note 3) | (292) | (5,553) | (5,845) | (286) | 1,166 | 880 |
| Other expenses | (471) | – | (471) | (375) | – | (375) |
| Net return before finance charges and taxation | 7,345 | (45,505) | (38,160) | 7,480 | 234,902 | 242,382 |
| Finance charges | (32) | (610) | (642) | (65) | (1,232) | (1,297) |
| Net return before finance | 7,313 | (46,115) | (38,802) | 7,415 | 233,670 | 241,085 |
| Taxation | (829) | 7 | (822) | (975) | 343 | (632) |
| Net return after taxation | 6,484 | (46,108) | (39,624) | 6,440 | 234,013 | 240,453 |
| Return per share (note 4) | 12.2p | (87.0)p | (74.8)p | 12.9p | 467.4p | 480.3p |
The “Total†column of this statement is the Income Statement of the Company. The “Revenue†and “Capital†columns are supplementary to this and are prepared under guidance published by the Association of Investment Companies. All revenue and capital items in the above statement derive from continuing operations and the net return after taxation is attributable to the owners of the Company.
The Company has no recognised gains and losses other than those shown above and therefore no separate statement of Total Comprehensive Income has been presented.
Statement of Changes in Equity
for the six months ended 30 September 2019
| (Unaudited) Six months ended 30 September 2019 £’000 |
(Unaudited) Six months ended 30 September 2018 £’000 |
|
| Opening shareholders’ funds | 1,432,093 | 1,202,188 |
| Issue of new shares | 15,733 | 20,994 |
| Return for the period | (39,624) | 240,453 |
| Dividends paid – revenue | (10,568) | (5,497) |
| Closing shareholders’ funds | 1,397,634 | 1,458,138 |
Statement of Financial Position
as at 30 September 2019
| (Unaudited) | (Audited) | |
| 30 September | 31 March | |
| 2019 | 2019 | |
| £’000 | £’000 | |
| Fixed assets | ||
| Investments | 1,400,770 | 1,378,681 |
| Derivatives – OTC swaps | 16,124 | 11,898 |
| 1,416,894 | 1,390,579 | |
| Current assets | ||
| Debtors | 6,319 | 12,330 |
| Derivatives – put and call options | 1,190 | 1,908 |
| Cash | 2,666 | 49,018 |
| 10,175 | 63,256 | |
| Current liabilities | ||
| Creditors: amounts falling due within one year | (25,605) | (18,230) |
| Derivative – OTC Swaps | (3,288) | 2,849 |
| Derivatives – put and call options | (542) | (663) |
| (29,435) | (21,742) | |
| Net current liabilities | (19,260) | 41,514 |
| Total net assets | 1,397,634 | 1,432,093 |
| Capital and reserves | ||
| Ordinary share capital | 13,296 | 13,150 |
| Share premium account | 404,830 | 389,243 |
| Capital reserve | 957,353 | 8,221 |
| Capital redemption reserve | 8,221 | 1,003,461 |
| Revenue reserve | 13,934 | 18,018 |
| Total shareholders’ funds | 1,397,634 | 1,432,093 |
| Net asset value per share – (note 5) | 2,628.1p | 2,722.9p |
Notes to the Financial Statements
1. ACCOUNTING POLICIES
The condensed Financial Statements for the six months to 30 September 2019 comprise the Income Statement, the Statement of Changes in Equity and the Statement of Financial Position together with the related notes below. They have been prepared in accordance with FRS 104 ‘Interim Financial Reporting’, the AIC’s Statement of Recommended Practice updated in February 2018 (‘SORP’) and using the same accounting policies as set out in the Company’s Annual Report and Financial Statements at 31 March 2019.
Going concern
After making enquiries, and having reviewed the Investments, Statement of Financial Position and projected income and expenditure for the next 12 months, the Directors have a reasonable expectation that the Company has adequate resources to continue in operation for the foreseeable future. The Directors have therefore adopted the going concern basis in preparing these condensed financial statements.
Fair value
Under FRS 102 and FRS 104 investments have been classified using the following fair value hierarchy:
Level 1 – Quoted market prices in active markets
Level 2 – Prices of a recent transaction for identical instruments
Level 3 – Valuation techniques that use:
- observable market data; or
- non-observable data
As of 30 September 2019
| Level 1 | Level 2 | Level 3 | Total | |
| £’000 | £’000 | £’000 | £’000 | |
| Investments held at fair value through profit or loss | 1,370,832 | – | 29,938 | 1,400,770 |
| Derivatives: put and call options (long) | – | 1,190 | – | 1,190 |
| Derivatives: put and call options (short) | – | (542) | – | (542) |
| Derivatives: OTC swaps (assets) | – | 16,124 | – | 16,124 |
| Derivatives: OTC swaps (liabilities) | – | (3,288) | – | (3,288) |
| Financial instruments measured at fair value | 1,370,832 | 13,484 | 29,938 | 1,414,254 |
As of 31 March 2019
| Level 1 | Level 2 | Level 3 | Total | |
| £’000 | £’000 | £’000 | £’000 | |
| Investments held at fair value through profit or loss | 1,353,865 | – | 24,816 | 1,378,681 |
| Derivatives: put and call options (short) | – | (663) | – | (663) |
| Derivatives: put and call options (long) | – | 1,908 | – | 1,908 |
| Derivatives: OTC swaps (assets) | – | 11,898 | – | 11,898 |
| Derivatives: OTC swaps (liabilities) | – | (2,849) | – | (2,849) |
| Financial instruments measured at fair value | 1,353,865 | 10,294 | 24,816 | 1,388,975 |
2. INCOME
| (Unaudited) | (Unaudited) | |
| Six months ended | Six months ended | |
| 30 September | 30 September | |
| 2019 | 2018 | |
| £’000 | £’000 | |
| Investment income | 8,108 | 8,141 |
| Total | 8,108 | 8,141 |
3. AIFM, PORTFOLIO MANAGEMENT AND PERFORMANCE FEES
| (Unaudited) Six months ended 30 September 2019 |
(Unaudited) Six months ended 30 September 2018 |
|||||
| Revenue | Capital | Total | Revenue | Capital | Total | |
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |
| AIFM fee | (62) | (1,180) | (1,242) | (60) | (1,146) | (1,206) |
| Portfolio management fee | (230) | (4,373) | (4,603) | (226) | (4,284) | (4,510) |
| Performance fee reversal for the period* |
– | – | – | – | 6,596 | 6,596 |
| (292) | (5,553) | (5,845) | (286) | 1,166 | 880 | |
* During the six months ended 30 September 2018, primarily due to underperformance against the Benchmark in the September 2018 quarter, a reversal of prior period provisions totalling £6,596,000 occurred.
As at 30 September 2019 no performance fees were accrued or payable (30 September 2018: £Nil accrued, £Nil payable).
No performance fee could become payable by 30 September 2020.
See glossary.
4. RETURN PER SHARE
| (Unaudited) | (Unaudited) | |
| Six months ended | Six months ended | |
| 30 September | 30 September | |
| 2019 | 2018 | |
| £’000 | £’000 | |
| The return per share is based on the following figures: | ||
| Revenue return | 6,484 | 6,440 |
| Capital return | (46,108) | 234,013 |
| Total return | (39,624) | 240,453 |
| Weighted average number of shares in issue for the period | 52,981,480 | 50,069,548 |
| Revenue return per share | 12.2p | 12.9p |
| Capital return per share | (87.0)p | 467.4p |
| Total return per share | (74.8)p | 480.3p |
The calculation of the total, revenue and capital returns per ordinary share is carried out in accordance with IAS 33, “Earnings per Share (as adopted in the EU)â€.
5. NET ASSET VALUE PER SHARE
The net asset value per share is based on the assets attributable to equity shareholders of £1,397,634,000 (31 March 2019: £1,432,093,000) and on the number of shares in issue at the period end of 53,180,278 (31 March 2019: 52,595,278).
6. TRANSACTION COSTS
Purchase transaction costs for the six months ended 30 September 2019 were £736,000 (six months ended 30 September 2018: £444,000).
Sales transaction costs for the six months ended 30 September 2019 were £325,000 (six months ended 30 September 2018: £334,000).
These costs comprise mainly commission.
7. PRINCIPAL RISKS AND UNCERTAINTIES
The principal risks facing the Company are listed in the Interim Management Report. An explanation of these risks and how they are managed is contained in the Strategic Report and note 16 of the Company’s Annual Report & Accounts for the year ended 31 March 2019.
8. COMPARATIVE INFORMATION
The condensed financial statements contained in this half year report do not constitute statutory accounts as defined in section 434 of the Companies Act 2006. The financial information for the half years ended 30 September 2019 and 30 September 2018 has not been audited or reviewed by the Company’s auditor.
The information for the year ended 31 March 2019 has been extracted from the latest published audited financial statements of the Company. Those financial statements have been filed with the Registrar of Companies. The report of the auditor on those financial statements was unqualified, did not include a reference to any matters to which the auditors drew attention by way of emphasis without qualifying the report, and did not contain statements under either section 498 (2) or 498 (3) of the Companies Act 2006.
Earnings for the first six months should not be taken as a guide to the results for the full year.
Glossary of Terms and Alternative Performance Measures (“APMsâ€)
Alternative Investment Fund Managers Directive (AIFMD)
Agreed by the European Parliament and the Council of the European Union and transported into UK legislation, the AIFMD classifies certain investment vehicles, including investment companies, as Alternative Investment Funds (AIFs) and requires them to appoint an Alternative Investment Fund Manager (AIFM) and depositary to manage and oversee the operations of the investment vehicle. The Board of the Company retains responsibility for strategy, operations and compliance and the Directors retain a fiduciary duty to shareholders.
Benchmark
The performance of the Company is measured against the MSCI World Health Care Index on a net total return, sterling adjusted basis.
Discount or Premium (APM)
A description of the difference between the share price and the net asset value per share. The size of the discount or premium is calculated by subtracting the share price from the net asset value per share and is usually expressed as a percentage (%) of the net asset value per share. If the share price is higher than the net asset value per share the result is a premium. If the share price is lower than the net asset value per share, the shares are trading at a discount.
Equity Swaps
An equity swap is an agreement in which one party (counterparty) transfers the total return of an underlying equity position to the other party (swap holder) in exchange for a one-off payment at a set date. Total return includes dividend income and gains or losses from market movements. The exposure of the holder is the market value of the underlying equity position.
Your Company uses two types of equity swap:
- funded, where payment is made on acquisition. They are equivalent to holding the underlying equity position with the exception of additional counterparty risk and not possessing voting rights in the underlying; and,
- financed, where payment is made on maturity. As there is no initial outlay, financed swaps increase economic exposure by the value of the underlying equity position with no initial increase in the investments value – there is therefore embedded leverage within a financed swap due to the deferral of payment to maturity.
Leverage (APM)
Leverage is defined in the AIFMD as any method by which the AIFM increases the exposure of an AIF. In addition to the gearing limit the Company also has to comply with the AIFMD leverage requirements. For these purposes the Board has set a maximum leverage limit of 140% for both methods. This limit is expressed as a % with 100% representing no leverage or gearing in the Company. There are two methods of calculating leverage as follows:
The Gross Method is calculated as total exposure divided by Shareholders’ Funds. Total exposure is calculated as net assets, less cash and cash equivalents, adding back cash borrowing plus derivatives converted into the equivalent position in their underlying assets.
The Commitment Method is calculated as total exposure divided by Shareholders Funds. In this instance total exposure is calculated as net assets, less cash and cash equivalents, adding back cash borrowing plus derivatives converted into the equivalent position in their underlying assets, adjusted for netting and hedging arrangements.
See the definition of Options and Equity Swaps for more details on how exposure through derivatives is calculated.
| Six months to 30 September 2019 £’000 |
One year to 31 March 2019 £’000 |
|||
| Fair Value | Exposure* | Fair Value | Exposure* | |
| Investments | 1,400,770 | 1,400,770 | 1,378,681 | 1,378,681 |
| OTC equity swaps | 12,836 | 110,607 | 9,049 | 116,762 |
| Put + Call options | 648 | 3,428 | 1,245 | 7,088 |
| 1,414,254 | 1,514,805 | 1,388,975 | 1,502,531 | |
| Shareholders’ funds | 1,397,634 | 1,432,093 | ||
| Leverage % | 8.4% | 4.9% | ||
* Calculated in accordance with AIFMD requirements using the Commitment Method
MSCI World Health Care Index
The MSCI information (relating to the Benchmark) may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is†basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Partiesâ€) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation lost profits) or any other damages. (www.msci.com)
NAV Total Return (APM)
The theoretical total return on shareholders’ funds per share, reflecting the change in NAV assuming that dividends paid to shareholders were reinvested at NAV at the time the shares were quoted ex-dividend. A way of measuring investment management performance of investment trusts which is not affected by movements in discounts/premiums.
| Six months to 30 September 2019 |
One year to 31 March 2019 |
|
| Opening NAV | 2,722.2p | 2,411.1p |
| (Decrease)/increase in NAV | (94.1p) | 311.8p |
| Closing NAV | 2,628.1p | 2,722.9p |
| % Change in NAV | (3.5)% | 12.9% |
| Impact of reinvested dividends | 0.8% | 0.8% |
| NAV Total Return | (2.7)% | 13.7% |
Ongoing Charges (APM)
Ongoing charges are calculated by taking the Company’s annualised ongoing charges, excluding finance costs, taxation, performance fees and exceptional items, and expressing them as a percentage of the average daily net asset value of the Company over the year.
| Six months to 30 September 2019 £’000 |
One year to 31 March 2019 £’000 |
|
| AIFM & Portfolio Management fees | 5,845 | 11,183 |
| Other Expenses | 471 | 908 |
| Total Ongoing Charges | 6,316 | 12,091 |
| Performance fees paid/crystalised | – | 3,135 |
| Total | 6,316 | 15,226 |
| Average net assets | 1,423,169 | 1,340,300 |
| Ongoing Charges (annualised) | 0.9% | 0.9% |
| Ongoing Charges (annualised, including performance fees paid or crystalised during the year) | 0.9% | 1.1% |
Options
An option is an agreement that gives the buyer, who pays a fee (premium), the right – but not the obligation – to buy or sell a specified amount of an underlying asset at an agreed price (strike or exercise price) on or until the expiration of the contract (expiry). A call option is an option to buy, and a put option an option to sell.
The potential loss of the buyer is limited to the higher of the premium paid or the market value of the bought option. On the other side for the seller of a covered call option (your company does not sell uncovered options) any loss would be offset by gains in the covering position, and for sold puts the potential loss is the strike price times the number of option contracts held. The exposure, used in calculating the AIFMD leverage limits, is determined as the delta (an options delta measures the sensitivity of an option’s price solely to a change in the price of the underlying asset) adjusted equivalent of the underlying position.
Performance Fee
Dependent on the level of long-term outperformance of the Company, a performance fee can be become payable. The performance fee is calculated by reference to the amount by which the Company’s net asset value (‘NAV’) performance has outperformed the Benchmark.
The fee is calculated quarterly by comparing the cumulative performance of the Company’s NAV with the cumulative performance of the Benchmark since the launch of the Company in 1995. Provision is also made within the daily NAV per share calculation as required and in accordance with generally accepted accounting standards. The performance fee amounts to 15.0% of any outperformance over the Benchmark (see page 32 of the Company’s Annual Report & Accounts for the year ended 31 March 2019 for further information).
In order to ensure that only sustained outperformance is rewarded, at each quarterly calculation date any performance fee payable is based on the lower of:
- The cumulative outperformance of the investment portfolio over the Benchmark as at the quarter end date; and
- The cumulative outperformance of the investment portfolio over the Benchmark as at the corresponding quarter end date in the previous year.
The effect of this is that outperformance has to be maintained for a twelve-month period before the related fee is paid.
In addition, a performance fee only becomes payable to the extent that the cumulative outperformance gives rise to a total fee greater than the total of all performance fees paid to date.
Share Price Total Return (APM)
Return to the investor on mid-market prices assuming that all dividends paid were reinvested.
| Six months to 30 September 2019 |
One year to 31 March 2019 |
|
| Opening share price | 2,730.0p | 2,405.0p |
| (Decrease)/increase in share price | (95.0p) | 325.0p |
| Closing share price | 2,635.0p | 2,730.0p |
| % Change in share price | (3.5)% | 13.5% |
| Impact of reinvested dividends | 0.8% | 0.8% |
| Share price Total Return | (2.7)% | 14.3% |
For and on behalf of
Frostrow Capital LLP, Secretary
20 November 2019
- ENDS -
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