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Daniel Lockyer: Polar Capital Healthcare launch exploits pharma revival

Polar Capital Global Healthcare Growth & Income Trust (PCGH) is currently in the marketing phase and has caught our eye for a number of reasons.

A key attraction is the idea for this launch comes from fund managers Gareth Powell and Dan Mahony, who have excellent credentials in this area, not a marketing department. They believe the healthcare sector hasn’t been this cheap for 30 years on most valuation measures. For example, the P/E ratio of large-cap pharmaceutical companies is trading at just 10 times earnings.
Cash flow is strong and good quality companies in the sector yield 4% to 5%.

The low valuations stem from concerns on patent expiry and generic competition, and the uncertainty over the recently passed US Healthcare Reform Plan. This has put generalist investors off the sector and Polar suggests the level of ownership of healthcare stocks is at a 20-year low. 

Pessimism about patent expiry and generics is overdone as it is a problem that is known about and overly discounted. There is so much focus on the loss of sales from existing drugs that the share prices of several stocks are cheap, even assuming no new drugs are discovered. The US reforms turned out to be less strict on price controls and there is likely to be decent volume growth with 30 million new US citizens set to receive healthcare.

Some great opportunities exist for drug companies. Large-caps are a good play on emerging markets, but at a much lower valuation than mainstream emerging market equities – around 15% of sales from drug companies listed in developed markets now come from emerging markets and this proportion is growing fast. There is also likely to be a pick-up in M&A activity now there is more clarity on regulations. The West’s ageing population also means healthcare spend as a percentage of GDP is unlikely to diminish.

PCGH’s structure is attractive and sensible. It will have a fixed seven-year life designed to capture the expected revaluation of the sector and to limit any potential discount. While investors wait for the re-rating and therefore the capital growth to come, they will receive a 3.5% pa yield. The management fee is a modest 0.85% pa with a performance fee only paid to the manager when the trust winds up – a real alignment of interests with shareholders and a firm long-term commitment by the managers.

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