As of last week, healthcare reform has a new price tag. According to the Congressional Budget Office, the plan unveiled September 16 by Montana Democrat Max Baucus would cost $856 billion over 10 years. But while politicians on Capitol Hill remain fixated on pinpointing direct costs, analysts on Wall Street are worrying about an even more elusive calculation: the downstream impacts reform would have on the markets.
In the years between the Clinton presidency and the current reform push, managers of mutual funds that specialize in healthcare have known it would be only a matter of time before Congress took up another legislative overhaul. And they have made their bets accordingly. "You see healthcare managers favoring companies that they think are going to make healthcare more affordable," says Christopher Davis, an analyst for Morningstar. "These shifts have been taking place before Obama became president, before healthcare became a top-of-mind issue."
Still, the healthcare campaign this summer has brought new urgency to fund managers' decisions. To complicate matters, this spotlight comes as healthcare stocks are at somewhat of a crossroads. In 2008, some managers bulked up on healthcare, betting on the industry's historical ability to weather downturns, but they have been unloading these holdings in favor of other sectors. "We're in an environment that favors industries that are kind of on the rebound, industries like financials or technology that really got beat up in 2008," says Davis. "And healthcare actually tends to hold up in rough environments, and so conversely when investors become more aggressive, they tend to leave healthcare behind."
Then there's the issue of valuing stocks. Congressional action has introduced significant uncertainty into the economy, leaving analysts unsure whether or not concerns are built into stock prices. At the same time, different sectors of the healthcare industry, which encompasses everything from pharmaceuticals to health insurance, stand to win or lose based on what bill—if any at all—makes its way through Congress.
To get a sense of how fund managers are reacting to legislative developments, U.S. News spoke with Robert Hodgson, the veteran manager of the BlackRock Healthcare Fund. The fund, which is diversified across the healthcare industry, has earned praise for its ability to weather uncertain environments. In 2008, the fund lost more than 26 percent, but it has returned a respectable 12 percent to date this year.
How does healthcare reform affect funds like yours on a day-to-day basis?
I think that as with everything else in Congress, most of this stuff has been leaked for months. So what you have to do is kind of read the temperature and assign some probabilities about whether some of the more onerous proposals get through or not. And at least I would say up until this point, we went through a period of time when people were factoring in the worst case . . . . As with what happened in the years in which the Clinton administration proposed their version of single payer, you went through a period of time when people [were panicking] to a period of time of them saying, "Well, there's a lot of resistance to that." And the stocks have reflected that.
As a fund manager, how do you respond to this environment?
You try to anticipate what other investors are going to be doing, for one, and take advantage. As I came into this, I did not think that we would see a draconian plan in place, so I was able to take advantage of sell-offs in stocks where I think the fundamentals are currently good and should remain good in what comes out.
Obviously, the prime example here is the HMOs; they've gone through a period of really bad performance. And I wouldn't want to single out any single one because they've all basically gone in lock step. There have been some individual nuances, but just as a group, they underperformed. And then people said, "OK, it's not going to be as bad as we thought," and so they all bounced up. That made somewhat of a V shape . . . . Other stocks that have done perhaps a bit better have been the pharma stocks. The large-cap pharmaceutical stocks have done better, because they went through a period of time where the impact on the pharmaceutical stocks was not so much from healthcare reform but the fact that a lot of them have very large products that are going off patent.
What about the level of concern in the industry? Are investors overreacting?
Let's face it: People should be concerned. Because it really is not clear what the objective of the healthcare reform is. Is it to get people insured, or is it to control the healthcare industry? If it's to get people insured, then I think there are other ways to have done it. If it's to control the industry, then that's a really bad situation for everybody who invests in this industry.
So it depends on where you come down on that spectrum. If you think that it is to control, then you probably don't want to be in the healthcare space. If it's to get people insured, then the worst-case scenario is not going to happen, and it's a great place to be. I personally think this is a great place to be, certainly over the long haul, because there are some really compelling fundamentals that are driving healthcare. The old [standby] is demographics. Everybody's getting older; as you get older, you use more healthcare services and more healthcare products. And the level of innovation just across the board in healthcare is phenomenal.
So with those attractive factors on the one hand and the doubts surrounding reform on the other, how do you strike a balance?
If you start with a premise that you want to look at a group that basically could do well under the legislative proposal, then you look for individual names. That's what I've tried to do. I've tried to look on an individual basis but with kind of a macro [focus].
What kinds of sectors stand to do well?
Biotechnology probably offers the best level of innovation of any of the healthcare subsectors. It also happens to offer a lot of interesting valuations at this point in time—companies like Celgene, for example, which is one of our top 10 holdings and has had a huge winner in the cancer space . . . . You've got companies like Gilead, which dominates for the treatment of HIV . . . . Other companies outside of biotechnology, companies that should, I think, do well under a healthcare reform environment—although it looks like they may be hit with some additional fees—are the prescription benefit managers. Someone is going to have to be responsible for managing the drug [expenditures], helping people get the best prices, helping [do] things by mail, helping—whether it's the HMOs or whether it's a government-run plan—put those packages and those programs together. And companies like an Express Scripts or a Medco Health would tend to benefit from that.
How many of these sector decisions will have to wait until the legislative picture becomes clearer?
I think that people are making their bets right now. We certainly are trying to triangulate in terms of looking for good valuations. I think what we can say is that the worst-case scenario seems to be off the table, which would be a government single-payer-type plan.
Corrected on 09/22/09: In an earlier version of this article, Robert Hodgson was quoted as saying "Someone is going to have to be responsible for managing the drug spin..." The correct quote is "managing the drug [expenditures]."