Equity Outlook  |  Q4 2019

2020 campaign changes health sector valuations

Jacquelyne J. Cavanaugh and Michael J. Maguire, CFA

2020 campaign changes health sector valuations

Jackie: The anticipation of a U.S. presidential election can have an impact on many sectors of the economy. Once again this year, issues related to health care are capturing the attention of candidates, the media, and voters. Political parties are advocating changes to address insurance coverage and drug costs, and the headlines they generate can be very disruptive to health-care stocks.

Mike: Election season and the "noise" it creates can take a toll on the price multiples that investors are willing to pay for health-care stocks. It is easy for candidates to ask provocative questions but difficult for businesses to provide quick and simple answers because the issues are so complex. We try to look past the noise and take advantage of price declines that result from short-term disruptions.

Managed care in the spotlight

Jackie: In April, Democratic candidate Bernie Sanders introduced a "Medicare for All" bill that would create a government-run system to provide health insurance for all Americans. Stocks of managed care companies plummeted in response. The reaction was based on the assumption that private insurers would have no role in such a system. We believe "Medicare for All" is not even a remote possibility, and all but a few candidates have recognized that it is unrealistic and fraught with problems. It is a headwind for the managed care sector, but we believe the "Medicare for All" risk the market is assigning to these stocks is far too high.

Mike: As managed care stocks were being unfairly punished in April, I added to Putnam Global Health Care Fund's position in UnitedHealth Group, making it the largest holding in the portfolio. I believed the stock price was extremely attractive relative to the company's fundamental strength and its potential to benefit from long-term growth drivers in the health-care sector, such as the aging population. That decision worked well as the stock recovered and advanced, but volatility and inefficient pricing remain across the managed care industry.

A positive force amid the noise: Medicare Advantage

Mike: It is difficult to find areas where politicians from both sides of the aisle are in agreement. Medicare Advantage, the privatized version of Medicare coverage, has been a resounding success in the view of Republicans and Democrats. Because of this and our aging population, many managed care companies are well-positioned for growth, regardless of the election outcome.

Jackie: Another tailwind for managed care could be the proposal to lower the eligibility age for Medicare. The "Medicare at 55 Act" would expand the addressable market for private insurers, bringing in new customers who are likely to have fewer health issues than older Medicare patients.

Drugs: Yea to innovation; Nay to higher prices

Mike: We also find bipartisan support when it comes to medical innovation. From gene therapies to next-generation targeted oncology, highly innovative assets tend to be viewed favorably from a legislative and regulatory perspective. Although these treatments are extremely expensive, politicians are generally committed to finding payment models that work.

On the other hand, drug pricing is a significant problem. Drugs are getting more expensive, and the co-pay structure is poorly designed. Politicians are pressuring retail pharmacies, drug manufacturers, wholesalers, and pharmacy benefit managers. It is an incredibly complex challenge, and will continue to be long after the election.

In my fund, I have generally avoided companies that have concentrated drug portfolios with significant exposure to reimbursement issues. Instead, I look for diversified product lines and innovative approaches that create better outcomes for patients.

Top 10 holdings as of 6/30/19:

Putnam Global Equity Fund: NRG Energy (3.77%); Amazon (3.21%); Nomad Foods (2.81%); Assured Guaranty (2.79%); Unilever (2.55%); Cenovus Energy (2.01%); Microsoft (1.97%); Advance Auto Parts (1.89%); BD Medical (1.81%); Enterprise Products (1.79%). Holdings represented 24.60% of the portfolio.

Putnam Sustainable Leaders Fund: Microsoft (6.76%); Visa (4.13%); Amazon (3.99%); Apple (3.52%); Adobe (3.51%); Danaher (3.39%); Unilever (3.02%); Novozymes (2.59%); BlackRock (2.47%); Alphabet (2.42%). Holdings represented 35.80% of the portfolio.

Putnam Research Fund: Microsoft (4.57%); Amazon (3.33%); Alphabet (3.07%); Apple (2.78%); Facebook (2.04%); Bank of America (2.00%); Procter & Gamble (2.00%); Home Depot (1.80%); Coca-Cola (1.78%); Citigroup (1.63%). Holdings represented 25.00% of the portfolio.

Putnam Global Health Care Fund: UnitedHealth Group (7.89%); Merck (7.64%); Novartis (6.16%); Danaher (5.80%); Johnson & Johnson (5.06%); Pfizer (4.16%); AstraZeneca (4.05%); Eli Lilly (3.84%); Roche (3.81%); Vertex Pharmaceuticals (3.57%). Holdings represented 51.98% of the portfolio.

Holdings will vary over time.

The S&P 500 Index is an unmanaged index of common stock performance.

The Bloomberg Commodity Index is a broadly diversified index that measures the prices of commodities.

The views and opinions expressed are those of the authors: Shep Perkins, CFA; Walter D. Scully, CPA; Jacquelyne J. Cavanaugh; and Michael J. Maguire, CFA, as of August 31, 2019, are subject to change with market conditions, and are not meant as investment advice.

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