The distinctive red-brick chimney of Bellevue Asset Management’s Küsnacht office makes it easy to navigate my way to Stefan Blum and Marcel Fritsch. Both fund managers remark on the fact that I am sitting with my back to the striking view of Lake Zurich. But as much as I would enjoy the tranquil landscape, my focus today is their Adamant Medtech & Services fund.
Next year the strategy celebrates its 10th anniversary. Having started as a closed-end product has transformed into an open-ended Luxembourg strategy with almost CHF 500 million in assets under management.
‘If you are below the CHF 1 billion I think it is very expensive to be a trust in Switzerland. You need to have a solution that fits everybody, which is a Luxembourg structure in my view,’ says Blum.
‘The first change after the switch was to diversify the portfolio as we used to have only six positions covering 80% of the strategy at the time. We also significantly increased our exposure to the US at the time,’ he adds.
As it stands today around 90% of the holdings of the fund are US-based companies. Blum says this is not a limitation as all these names are truly global rather than domestic. In addition, the majority of the fund’s investors are European and appreciate exposure to a market they know less about.
Just the tonic
However, this American edge is not the only reason why the strategy stands out from the competition. Despite tapping the healthcare sector the fund invests in everything but drugs.
Blum says the idea behind this was to avoid the deficiencies of traditional healthcare funds that often concentrate on the volatile biotech and pharma sectors.
‘If such strategies want to outperform they add more biotech, which results in more beta. It works really nicely in a positive market, but when things turn less favourable you are in trouble, because you have too much beta and not enough safe haven pharma bets.’
The medtech and services sector offers more stability when things go wrong while still offering room for innovation, Blum says. Sometimes people have the misperception that the medtech and services is a niche sector, he adds, because pharma is a huge part of the MSCI World/Health Care TR index.
But this index doesn’t reflect the reality, which is that the majority of the total healthcare costs fall within the medtech and services. ‘Looking at the global GDP you have 12% healthcare, and 10% of it we are covering in the fund,’ he says. ‘We chose the toughest benchmark possible, so even if we don't kill the benchmark we kill the competition, so that's easy,’ Blum jokes.
The fund’s big strategic shift happened in 2015, when it started adding more services-related companies, which now make up 20% of the fund.
Firtsch says before the fund moved into services the team made a historical analysis of the risk/return profiles of medtech and services portfolios separately versus portfolios that combined the two sectors.
‘The conclusion was that both sectors are attractive, but if you combine them then you have a slightly better return and slightly lower risk because the correlation between the two is very low.’
Blum says patient care is changing, which means the future lies with insular players that will take on patient management for hospitals.
‘Those patients will fall within the controlled group where you know how many hospitalisations they require per year. That will change the game dramatically because you are not selling products but taking care of a patient instead.’
Historically, Fritsch is the one who focuses on the services sector, although the two have a shared responsibility for the fund. Although his professional background is not directly connected to healthcare services, Fritsch spent three years at Deloitte providing strategic advice to multinational medical technology, pharmaceutical and manufacturing companies.
This experience gave him an edge when he became a portfolio manager at Bellevue Asset Management in 2009.
Fritsch says the managed care theme was on their minds for quite some time, but it was difficult to invest initially. For example, in 2016 there were two major pending mergers in the market, and the companies the fund managers liked didn’t trade at all as they were expecting regulatory approval.
‘The performance of that sector was also not really good at the time so we waited until that standstill situation cleared,’ he says.
‘What we see right now is that large insurance companies are buying patient management companies to better control very expensive procedures. So that's all about cost control, which is very important in that part of the industry.’
He adds that it is important to have solid expertise in the services space, which is an integral part of the medtech business. ‘Otherwise it is like flying without radar straight into the fog. Services really give you an ability to understand in which direction the market is developing.’
Blum says the healthcare system overall will gradually move from curing diseases to preventing them in the first place.
Part of this paradigm shift is the increasing relevance of the digital healthcare, which includes areas like augmented reality, advanced imaging, sensors, 3D printing, miniaturisation, navigation, robotics, cloud integration and big data.
‘People go to the hospital and then they are sent back feeling lost. You can avoid that if you connect patients to the cloud where they can get support from their doctors and get additional services,’ Blum says.
Frisch adds that you can already find players that are taking advantage of data analysis. For example, UnitedHealth has a subdivision, Optnm, which collects data from insured people to work out specific patterns and better manage patients as a result.
Providing the right care for chronic patients in the long term requires you to source a lot of data in advance. ‘If you look at managed care companies, those are looking after patients with chronic diseases like diabetes. The main aim is to sustain their current state of health because if it worsens, it becomes much more expensive to treat them,’ he explains.
As a result, the fund managers allocate capital to companies that are ready to invest in better technology and make good use of big data.
Blum says companies like Google and Apple are the furthest along when it comes to patient data collection. ‘For example Apple developed an app that collects all your electronic medical data, which was non-transferrable before, in your iPhone. So the next time you need an emergency treatment doctors will know all about your specific situation.’
The fund managers don’t invest in Google and Apple yet, although Blum doesn’t rule out this possibility if the companies spin off their healthcare data businesses.
In the meantime, there are smaller players in the market that are taking advantage of the big data trend. One case at point is a non-listed Proteus Digital Health, which specialises in the production of sensor patches linked to mobile applications.
In the listed space one holding that has made significant progress in this theme is GN Store Nord, a Danish hearing aid manufacturer. ‘The company was one of the first players to put its software to the cloud, which allowed clients to do remote fitting of the hearing aid devices,’ Blum says.
One example of one of these companies in diabetes treatment is Medtronic, with its integrated system combining insulin pumps and continuous glucose monitoring, and FreeStyle Libre, which manufactures glucose measurement devices.
‘This way you can prevent amputations, which is not only a very traumatic experience for the patient but also costs thousands of dollars,’ Blum explains. ‘In chronic heart disease patients you can produce a monitoring device with particular algorithms that will signal that the likelihood of a patient getting a stroke is increasing.’
In Fritsch’s view another increasingly popular theme is augmented reality, where one of the interesting players is Philips with its cardiac imaging technology.
Robotics is also making waves across a whole range of different sectors, and medtech is no exception.
‘Stryker, for example, has a knee and a hip robot, while Medtronic implements robotics for surgical heart and diabetes.’
Barriers to entry
Talking about future growth drivers in the medtech space, Fritsch says one of the most important areas for the next five years will be the aortic valve repair and replacement market, which is projected to grow by $5 billion by 2021.
‘There are both smaller unlisted companies and bigger players like Boston Scientific and Edwards Lifesciences that are working in the space,’ he says. ‘These companies work on the systems that repair triscuspid valve and mitral valves, for example. There is also space for M&A activity in the sector.’
The fund managers also expect a spate of approvals in 2018 and beyond, including tricuspid valve repair system Cardioband TR, and Forma Spacer, transcatheter mitral valve repair system Pascal, and transcatheter mitral valve replacement system CardiAQ.
Barriers to entry in the industry are quite high, and distribution channels are relatively well protected in comparison to the drugs-driven sectors.
‘Most of the time you have three to maybe four competitors in the huge markets. Let’s take for example transcatheter heart valve where you have two companies that have FDA approval in the US and where Edwards Lifesciences, which started around eight years ago, is still a duopoly,’ Fritsch says.
‘We of course expect some new players to enter the market in the next one to two years, but then you will maybe have four players in the market where two will hold 70% – that means it is still a very niche environment.’
Blum says the overall medtech space is for those investors who don’t like to take on too much risk, because if you are not afraid of drug pricing risk then you are better off investing in biotech.
‘If you want to have the biotech innovation in the portfolio then you can go to our colleagues BB Biotech who have CHF 4 billion under management. If you combine medtech and service and biotech together, then you really have everything in the healthcare space.’
This article was originally published in the March 2018 issue of Citywire Switzerland.