By Diane Wehner, Senior Portfolio Manager, Citi Investment Management
April 5, 2018
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The healthcare industry is experiencing unprecedented change
Healthcare historically has been a unique and attractive sector in which to invest over the long-term as healthcare companies, in aggregate, have demonstrated stronger earnings growth relative to the broader market as well as defensive attributes during downturns.
Now is a particularly opportunistic time to invest in the health sector as the industry is experiencing unprecedented change driven by global demographic trends and innovation in both the treatment of diseases and the delivery of services.
We are currently undergoing a major shift in global demographics with an aging population and an emerging middle class in developing parts of the world. With the number of people over 60 expected to double by 2050, a secular tailwind of healthcare demand is gaining strength as the elderly generally spend more per capita on healthcare than any other age group.
In China (where the 380 million person middle class is greater than the entire US population) and other emerging markets, a growing middle class is leading to increased demand for better healthcare solutions. In addition, the adoption of Western diets in these parts of the world is resulting in a higher incidence of obesity and diabetes and, as a result, an increased need for effective treatments.
The cost to society to meet the healthcare needs resulting from changing demographics could rise steeply, with healthcare spending accounting for an ever-greater proportion of the economy. These powerful trends are driving innovation and the development of disruptive technologies in the healthcare space.
The successful sequencing of the human genome in the early part of the century resulted in the emergence of precision medicine and the potential for personalized treatment of each patient’s condition.
Gene editing and immunotherapy are novel treatment approaches to diseases, such as cancer, and represent custom-made solutions. Wearable devices and robotics used in the diagnosis and treatment of diseases are improving patient outcomes and lowering overall healthcare costs as well.
The healthcare business model is also transitioning away from a payment system based upon fee-for-service to an outcome-based system. In other words, reimbursement to doctors and hospitals will be based upon how well the patient’s health issue has been addressed rather than charging for the visit.
Even though significant progress has been made so far, we believe the transformation is still in the early stages with a vast opportunity set ahead. We believe innovation will continue to accelerate as the industry applies artificial intelligence and big data analytics to the enormous amounts of information already being collected.
Providers will evolve from offering discreet services to holistic solutions. In some instances, innovative companies will garner first mover advantage as their technology will be their competitive advantage. In other areas, multiple companies can share the limelight offering different but effective solutions to some of our most difficult healthcare issues. These scenarios all represent potential investment opportunities.
At the macro level, looking deeper at emerging market fundamentals reveals strong tailwinds. Developed countries spend on average around 10% of their GDP on healthcare while China just recently reached 5%, clearly underspending by comparison.  This is where we anticipate seeing material spending increases and soaring demand.
We are seeking to take advantage of these wide-ranging healthcare opportunities by investing in companies positioned to potentially benefit from these factors due to their dominant market share position, innovative technology, or holistic service offerings. For example, immunotherapy research solutions are being developed by large cap pharmaceutical and biotech companies, with several conducting clinical trials on lung cancer which is a potential $20 billion market opportunity.
In addition to investments in pharma and biotech companies, we look to invest in information technology innovators: for example, companies that develop and provide the underlying hardware and software that enable the development of these novel approaches to tackling disease, such as that used in genetic sequencing.
These innovators will benefit regardless of which drug is successful. In addition, broader application of the technology becomes possible as it moves down the cost curve, essentially democratizing the technology and expanding the overall market opportunity as a result.
Our healthcare portfolio strategy also seeks an idiosyncratic approach to investment selection. This is exemplified by our recent interest in liquid biopsies, an emerging technology. The successful development of this technology would allow doctors to conduct a pan-cancer analysis of a patient to detect multiple types of cancer exposures using only a blood test.
The implications of such a simple cancer screen could be extraordinary and a handful of companies are aggressively researching this technology. Rather than working out which firm will “win” the race and then investing exclusively in it, we are keen on identifying and buying the companies that will provide the underlying technology those in the race will require.
In light of the recent market volatility, it is important to note that the healthcare sector is considered to be both defensive and a relatively resilient segment of the economy. The need for pharmaceuticals, medical procedures, and services are generally not discretionary, and our strategy seeks to invest in fast-growing, innovative companies that are relatively insulated from the ebb and flow of the macro-economy and represent solid long-term investment opportunities. Additionally, the sub-sectors of the healthcare sector range from pharmaceuticals and medical device manufacturers to service providers like hospitals and managed care organizations, helping to provide investors with industry diversification.
 United Nations, via Haver, as of October 24, 2017. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events.
 There is no standard definition of a middle class level of income. CIM applies a broad definition of “middle class”, which encompasses people making on average $5,800/year (emerging middle class) as well as those making on average $11,700/year (established middle class). For additional information on the middle class, see: pewglobal.org/2015/07/08/a-global-middle-class-is-more-promise-than-reality/
 genome.gov/sequencingcostsdata/ Data as of July 31, 2017. Accessed November 14, 2017.
 Collier, M., Fu, R. Yin, L. (2017). Artificial Intelligence: Healthcare’s New Nervous System. accenture.com/t20170418T023006Z__w__/us-en/_acnmedia/PDF-49/Accenture-Health-Artificial-Intelligence.pdf Accessed November 28, 2017
 World Bank data.worldbank.org/indicator/SH.XPD.TOTL.ZS Data as of December 31, 2014