Why I’m buying shares in my own trust

The BB Healthcare Trust has delivered eye-catching returns over five years, but over the past year performance has been more subdued. Its fund manager Paul Major explains why it has been a challenging period, and argues why now is a great buying opportunity. 

Kyle Caldwell, collectives editor at interactive investor: Hello. Today I have with me Paul Major, fund manager of the BB Healthcare (LSE:BBH) investment trust. The BB Healthcare Trust invests in companies that are making clever use of technology and coming up with innovations to transform and fix the global healthcare system. BB Healthcare Trust was launched over five years ago. How would you assess performance since launch and what's been the key performance drivers?

Paul Major, fund manager of BB Healthcare Trust: If we think on a five-year metric then we've outperformed the MSCI World Healthcare benchmark, we've delivered I think good results relative to sort of portfolio volatility so our Sharpe ratio is very good. I think we've broadly outperformed our peers over that longer period of time as well. So in that sense, I think we can we can be satisfied that we've demonstrated through a variety of market conditions that in terms of long-term returns and we're focused on rolling three-year performance as our internal metrics of measuring how we're doing.

I think we've demonstrated that the strategy we have is scalable as the trust has grown and that it can deliver positive, long-term returns over various market conditions. I think if I had a frustration thinking about the world since 2016, and I'm sure any portfolio manager would say the same thing, I'd love a normal market. I mean, I think 2017 was the last year where there wasn't some enormous macro problem or some bizarre issue that caused the market to sell off or elevated volatility or something like that. And it's a bit exhausting, really, to not live in a normalised world. I think we can be broadly satisfied.

I think the last kind of six months, as I say, have been a little bit tougher as the market tries to think about where do we go from here? As the world normalises and we think about what's the sustainable price of growth, what's normalised interest rates, all those things macro wise, I think, are creating a lot of volatility and rotation within the market. And at the moment, you know, healthcare is out of favour, as we've seen and really particularly over the last two months relative to the broader marketplace. But if you take a step back from that and I think you reflect longer-term healthcare over five, 10, 15 years, ex tech has always been one of the most consistent and best-performing sectors. And there were very, very few areas of the market where you would find any investor turn around and say, I have, because of demographic factors, the ageing and growing population, rising global wealth. I have visibility over demand growth for the products and services I'm investing into for as long as anyone cares to forecast. I mean, other than, you know, electricity companies or something like that, you can't be confident that demand is going to grow and grow and grow in a very, very predictable way. And then on top of that, we're in the fortunate position that we have medical innovation.

So as we unpick how the human body works at a molecular level, we can create new treatments, new approaches to ever more diseases. And you look at the excitement around things like gene therapy and stuff like that. We can imagine a world 10 or 20 years now where we've increased exponentially the number of human maladies that we can actually address. So that creates even more market growth. So I think nothing has changed over that five-year period from my perspective about the level of excitement I have over the sustainable growth of this industry over the long term, and especially if we can address some of the productivity issues that we have, we can improve affordability and that creates that headroom to pay for this next generation of innovations.

Kyle: You've just touched on it but I was wondering if you could expand further on performance over the short term, as over the past year, the performance of the trust's share price and the net asset value return is more subdued, particularly in comparison to the five year performance.

Paul: Sure. Institutional investors often talk about factors, you know, different characteristics in the market that drive performance. If you disaggregate the factors that have really characterised broad market performance over the last six months, I mean, inevitably, they change. But the world began to change in November 2020, when people decided that the pandemic was in abeyance early, they were too early, inevitably, but that was the broad view, and people wanted to be pro-cyclical, you know, pro-consumer. And there was a bit of a shift away from growth to value. All those things were broadly challenging for healthcare, but we've been in a situation where people have pursued premium growth-type companies in favour of more value, more diversified, larger companies. And, you know, say the Johnson & Johnson's and the Pfizers of the world, which generally you would view as less exciting, have been where people have wanted to be positioned and they've chosen to have less stuff further down the market cap spectrum.

So we are at our heart focused on small and mid-cap healthcare innovation companies that are very operationally geared and focused on specific areas. And if you ignore our portfolio and you look at a broad market, generally speaking, if you look at indices that are focused on small innovative companies like the Russell 2000 index in the US versus, say, the S&P 500, over a five or 10-year view, what you'll see is you get a bit more volatility in the small-cap indices, but you get a lot more performance because these are the companies that are creating the next generation of products and services for humanity. That trend completely reversed in 2021. So it was a very, very challenging market dynamic for our strategy and coming back to my one of my early responses. You know, we have a framework. We've demonstrated it works over the long term. We're not minded to change it because market fashion is slightly different. So it's been a very, very challenging macro environment and I think it was inevitably going to be difficult for a small, mid-cap portfolio to keep up with a benchmark that's dominated by a small number of mega-cap companies when those companies are particularly in favour.

But there's never been a dynamic where these small, mid-cap companies have underperformed for a sustained period of time, so I can't say when the next rotation back the other way is going to begin. But I'm very confident that it will happen. And when we look back, you know, a year or two years from now at asset prices in these areas we will view this as a great buying opportunity. And because what we've seen in that small, mid-cap space is quite a disorderly sell-off. It's not company specific news flow that's driving what goes up or what goes down. It's what sub-sector of healthcare you're in.

If you're a healthcare technology company, healthcare IT company, a biotechnology company, you can't do anything right at the moment. Good news, your share price just goes down less than if it's bad news, but as I say, these are generally transient periods. And if you look at history, you know, March 2020, December 2018, which is similar in magnitude of the underperformance of healthcare and this kind of small mid cap dynamic. What followed was a tremendous opportunity, so we've been increasing our gearing, increasing our exposure to find them at valuations we think are very, very attractive.

Kyle: And increasing your gearing levels, that's obviously a sign that you're pretty bullish at the moment. I was wondering if you could name a couple of sectors or individual companies that you've been buying with those increased gearing levels?

Paul: Sure. So we've tended to focus on, so the areas that we've really liked through this are some of the specialised diagnostic stocks, some of the biotechnology, we call them focused therapeutic companies, that are focussed on more specialist areas of medicine. And then some of the services related companies. So, you know, objectively, if you take a step back, if you're a biotech-type company, then what dictates your future share price performance isn't macro conditions, it isn't the economy. It's whether or not you can deliver the scientific data that shows your products are better than what's currently available. And that's got nothing to do with the economy. So it's those companies have sold off during this wave, a lot of them have become very, very compelling. I think this is a very, very interesting point for novel therapeutics, particularly in areas like gene therapy, where we've been talking about the promise of this for five years and we haven't had the conviction necessarily that these things are going to work. I think the evidence now is very much to the positive and it's just a matter of time before we see these things being approved and becoming more mainstream therapy. So we've been buying a company called Sarepta (NASDAQ:SRPT), for example, which is a leader in gene therapy. Diagnostics, very broadly, you know, again, if you come back to that point about patients entering the system, getting the right care critical to that is understanding what's wrong with them. And there are more and more molecular level diagnostics that enable you to pinpoint exactly what's going on in somebody's body and why that's making them feel unwell. And we've taken advantage of the volatility again to buy into some high performance diagnostics, particularly in areas like monitoring transplant patients. And we continue to see novel diagnostics as a huge area. And finally around services, you know, one of the big challenges we face, particularly in America, where the healthcare system is incredibly complicated. It's the world's biggest market for healthcare, but it's just so fragmented and difficult. Lots of people talk about the fact that lots of people don't have access to healthcare in America. But a more pressing problem in many ways is that most people don't utilise the healthcare that they have because they don't necessarily understand what is or isn't available to them. And this becomes doubly problematic if you already have a complex medical condition that you're trying to manage. So we own some companies that are simplifying how to match patients with care, with carers, with hospitals, with insurance providers, to optimise the outcome for them. This is a fairly novel area, but one that you can imagine is going to continue to grow as the population ages and more and more people with potentially complex conditions, you know, dementia, arthritis and these sort of things that require quite a lot of interventions and management. So, we see an abundance of opportunities and that's precisely why the gearing is going up because we're drawing down on our bank facility to deploy more capital into the market because we see these valuations as incredibly compelling.

Kyle: As someone considering investing a part of their portfolio in a healthcare fund or investment trust, what would you say is the main attraction and the main risk to bear in mind?

Paul: Sure. So as we've touched on, if you look at the panoply of funds that are out there, the first thing is you've got lots of different geographical or sub-sector exposure, so you could buy a biotechnology fund or services fund or a medical device fund or something like that or an innovation fund. I think certain areas are inevitably going to do better or worse at certain points in the cycle of healthcare. And so for me, if you're not experienced in this area, I think firstly you should use an active manager who has some ability to discern whether it's the right or wrong time to do things.

Ssecond, I think you should probably go for a broad-based approach rather than one of these sector-specific funds or one that's tilted towards, if you look at most investment mandates, they tend to tilt towards a certain area of healthcare. We're in the fortunate position, we have an unconstrained investment mandate, so we can we can ebb and flow as we see the relevant opportunities. I think you have to recognise that some of the, this is a very complex industry. There's a huge amount of regulation, there's a huge amount of science. And if you look at the risks around drug development, they are actually quite high. It's a very expensive, time-consuming business with probabilities of success, certainly based on historical evidence that are quite low. So I think you need to recognise that you're going to have maybe a little bit more volatility in some of these areas than you would do in other market sector funds that you might buy.

But I think the primary attraction of it, as I said, is the demographic drive. As you know, there's one thing that unites everybody on this planet. We're all going to get sick at some point. We're all going to need healthcare services. And if we're fortunate enough to live to a ripe old age, we're going to use those services to an increasing degree as we age. So if we think about society and how society is changing and how the world is globalising, this is an industry with incredibly powerful, long-term structural drivers that, as I say, I personally think are unique. The level of confidence we have in the outlook is probably unique, and that's why I personally think that healthcare should be something that people allocate to within their portfolio.

But at the same time, you shouldn't be looking at performance over, you know, three, six or nine months. You should be putting this there and then you should be taking a view that it's a five-year or 10-year investment. And if you think about it on that basis and you look at charts of sectoral performance or fund performance over long periods of time, I think you'd see that over these very long periods of time, it does very, very well.

Final thing I would say, because I think it's important to private investors, we pay a dividend out of our fund, we pay it out of capital. We don't pay any attention to dividends paid by healthcare companies themselves. And I think dividends are something that investors need to be extremely cautious about when they look at healthcare companies.

There may be a temptation if you're a private investor to buy a big company because it's got an interesting dividend yield and it's a healthcare company. This is a growth sector. It rewards top-line growth above all other things. It's also a sector of continuous innovation and obsolescence. Just because you're winning today, it doesn't mean you're going to be winning in three or five years' time because the world is ever changing. And if you are seduced by dividend payout ratios from companies, what you tend to find is when those companies products start to fall away as inevitably they will, they are then constrained in their ability to buy in innovation because they're paying out their cash flow to fund a dividend. So if you are going to engage in stock-specific, you know, direct investments into healthcare companies, please don't look at dividends. Look at long-term, top-line growth and valuation metrics and ignore dividends, because this industry, I don't think dividend yields work as a way to pick stocks in healthcare. 

Kyle: And finally, do you personally invest in the BB Healthcare Trust?

Paul: Yes, I do. Funnily enough, my last PA, and I obviously own a substantial amount of the trust relative to my own net worth anyway. But the last thing that I did in in December was took advantage of the volatility and the low share prices to make a substantial additional investment myself because, as I alluded to, I think this is a in longer-term terms this is a very, very significant opportunity, with valuations being as dislocated from reality as they are at the moment.

Kyle: Paul, thank you very much for your time today.

Paul: Thank you.