Health and wellness is a long-term investment theme we like here at FIM. This month, two FIM investment committee members, John Bresnahan and Zach Liggett, discuss our investment process in this sector and highlight a few of our current holdings.
Zach Liggett: Well, to start off with, there are common traits we look for in any investment. Sustainable competitive advantages, capable management, conservatively managed balance sheets, and business models that can ultimately generate strong, free cash-flow are just a few of the basics. We look for these characteristics in companies across geographical borders and throughout a wide variety of healthcare subsectors. Our portfolios today hold leading companies in healthcare consumer products, cancer-fighting prescription drugs, and medical devices. We also own healthcare service providers in parts of the world benefitting from privatization and public-provider outsourcing trends, as well as companies that specialize in developing and owning healthcare-related real estate.
John Bresnahan: We begin by categorizing the space in a different way than is standard; for me, this is all about innovators and implementers. In practice, this means we are going to be looking for companies with defensible positions – an economic moat, in financial industry parlance; this economic advantage will look different than, say, the steel industry where sheer scale can be extremely important. Within healthcare the landscape is dynamic, so a defensible position to us ranges from the nuances in the business model or the geographic footing of a healthcare provider to strong science backed by research and development for pharmaceutical, biotechnology, medical devices, and hardware.
At its simplest, we are first looking for entities that are spending at least as much on the science as they are on the sales and marketing (which is surprisingly rare) and for companies that are making tangible breakthroughs for indications of true need. This means that we have been avoiding (no matter how attractive the bare numbers might appear) such entities as the generic drug makers, distribution channels, simple disposables, immature science, controversial science, cosmetics, and the like.
A few areas that interest us are treatments for rare diseases where pricing is reasonable; oncology, where the advancement is novel, not trivial; vaccines and antibiotics; wound care (as in advanced bandages); and classes of medications and treatments one step back from the vanguard – all backed by hypotheses that have been empirically tested, in large-enough studies, against either the gold standard or a strong comparator in instances where standards of care aren’t highly efficacious.
ZL: Here in the U.S. there is no shortage of large-scale changes being debated in Washington, D.C.: Major drug pricing and rebate overhauls, ACA repeal, and Medicare-for-all are only three of the biggies. Internationally, too, public policy choices can drive significant threats and opportunities for healthcare businesses. Some countries are just now beginning to open themselves to more private sector involvement, while others are rolling out universal health coverage schemes. As public policy can change quite suddenly, we look for companies that are not overly dependent on any one policy outcome. We also use our own position sizing (that is, deciding how much to own of a given stock in a particular strategy) to help mitigate these risks.
JB: We’ve been closely scrutinizing the pricing of treatments when reviewing companies, as we believe this is better for patients and ultimately also for the companies. If you’re overpricing your product or service, it’s only a matter of time until you draw the spotlight to your company and invite resultant (but likely justified) over-regulation.
Finland, for example, is undergoing massive social and healthcare reforms; its Nordic neighbors have already undergone these shifts, so there is a clear schematic to follow. The opportunities presented to us will be good for the patients, for public finances, and for healthcare providers. Two of the three healthcare providers in Finland are public, and we are invested in both – Terveystalo and Pihlajalinna. Ultimately, we believe all three (including the third, Mehilainen) will be able to thrive.
JB: The Finnish healthcare providers are great, but they lack one thing that attracts us more generally to the sector (that is, to treatments and devices): the ability to scale globally. Put simply, research and development dollars can go quite far. So, while you’ve got Roche and Philips, both from Europe, they are actually every bit as global or international as, say, Merck and Regeneron from the U.S.
That said, we do find international organizations that operate under different structures, which usually are most pronounced at the management and board levels; so, there is an attraction there, as you tend to see, and – here I’m generalizing – longer horizons plus a greater commitment to the balancing of stakeholders’ and shareholders’ interests.
ZL: I’ll add that we are also looking quite actively in emerging markets for healthcare stocks. Many of the demographic and healthcare consumption trends are even more compelling in these countries, relative to more developed ones longer term. For example, the Indonesia conglomerate Lippo Karawaci, through its majority-owned subsidiary Siloam International Hospitals, runs 33 hospitals across 24 cities in that populous nation, with another 17 hospitals in the development pipeline. Indonesia’s healthcare tailwinds include significant population growth, very low levels of current per capita healthcare spend, and growing middle class affluence. Hospital-bed-to-population ratios there are far below global averages and provide opportunities for private operators like Siloam to fill the gap.
JB: Tremendous amounts of capital have been ploughed into research and development in healthcare. As with other sectors, we continue to see many startups chasing all sorts of indications – of course, the hotter areas, such as gene editing, are seeing the most.
So, there are a lot of exciting things going on, but I think in merely realizing our own limitations, we’ve decided to take a more cautious tack within this investible universe. We’re willing to do the deep dive on pre-revenue companies employing promising science, but you’re going to see us gravitating toward entities where the science has been around a bit longer, where trial sizes are sufficient to suss out signals and side effects, where they’ve got at least a couple of assets being worked on, and where partnerships help to buttress both the balance sheet and the income statement.
At the end of the day, you’re talking about treating individuals, and I really don’t like the idea of testing shallow hypotheses on my friends and neighbors! That is not to say that great work isn’t being done in genetic editing or RNA interference, for example, but my comfort level simply isn’t there yet. Then you factor in that these spaces are hot right now and that valuations become challenging without a lot of faith, so to an investor the story becomes more muddied.
If not there, then where? Today we’ve got two entities, with newly approved drugs, that are transitioning from discovery and clinical trials into commercialization. Both have deep pipelines, strong partnerships with industry leaders, solid balance sheets, and science that has been heavily published or peer reviewed. Most important, we believe that their corporate cultures foster good science and that their morals and ethics are solid.
ZL: Another way we gain exposure to these early-stage companies is indirectly, though our holding company investments. For example, in the Japanese telco and technology conglomerate Softbank we have exposure to the Ping An Healthcare and Technology Company, China’s largest provider of online healthcare services. And through the Belgian investment holding company Quest for Growth, we have exposure to both the French oncology diagnostics company HalioDX and the German implantable fluid pump systems company Sequana Medical. By owning early-stage companies through holding companies like Softbank and Quest for Growth, we can tap the specialty expertise that these management teams bring to deal-sourcing as well as to the due diligence process, while at the same time tempering the volatility that can come with direct investments.
As you approach your 70th birthday, you should be aware that you must begin taking minimum annual distributions from your traditional IRAs no later than April 1 following the year in which you reach age 70½.
The tax rules require minimum annual distributions to be made, to help ensure that IRAs are used primarily to provide for retirement rather than as a family tax shelter.
Fortunately, IRS regulations favor the IRA owner who wants to make the smallest possible withdrawal each year. For example, applying the rules that are used by most IRA owners, if you reach age 70½ during Year 1 and your 71st birthday falls within the same year, then:
Minimum annual distributions are smaller if your spouse is the sole designated beneficiary of your IRA and if she or he is more than 10 years younger than you.
Complications may arise if you have multiple IRAs. For example, the minimum distribution is calculated separately for each IRA, but the total minimum distribution for all of them may be paid out from one IRA or from a combination of IRAs. And you could be hit with a 50% penalty tax if you don’t withdraw the required minimum amounts. These are just a few of the many reasons for you to get together with us at FIM to review how the minimum distribution rules affect your retirement, estate, and financial plans.
If you inherited a traditional IRA (or even a share of one), you should know that you may be able to improve your tax picture by taking timely action and “reshaping” the method of sharing and distributing the IRA. Rest assured, however, that this won’t involve thwarting the wishes of the IRA’s owner. In some cases, effective post-death planning simply means dividing one IRA into several. In other cases, it adjusts payouts to give all the beneficiaries the best result.
The right kind of post-death planning for an IRA depends on how the IRA owner directed that its proceeds be shared. Here are three examples:
Before she died, Mom designated Son and Daughter as equal beneficiaries of her IRA. Son will attain age 50 this year and wants to invest the inherited IRA in a money-market fund. Daughter will attain age 44 this year and wants to invest the inherited IRA in an asset-allocation-type mutual fund. If the IRA is left as-is, the payout for each child will be based on Son’s life expectancy. And the siblings will likely find it hard to reconcile their differing investment philosophies. However, if Son and Daughter timely direct the IRA trustee to split Mom’s IRA into two equal IRAs, Son’s payouts would be based on his life expectancy, and Daughter’s on her life expectancy. Because Daughter’s life expectancy is longer than Son’s, her payouts will be made over a longer period than his. Son can invest his half of the IRA in a money-market fund, while Daughter can invest her half in the mutual fund of her choice.
In a different family, Dad named Mom and their children as equal beneficiaries of his own IRA, but the children don’t need the income now. If they disclaim their interest in that IRA on a timely basis, Mom will be treated as the sole beneficiary and can elect to treat Dad’s IRA as her own. This way, she can (1) name the children as beneficiaries of the IRA, (2) defer commencement of payouts from the IRA until April 1 of the year after the year in which she attains age 70½, and then (3) begin taking payouts over a longer payout period than she’d be entitled to as a beneficiary. After Mom dies, the balance remaining in the IRA will be paid out to the children. If the children don’t disclaim their interests on a timely basis, Mom can’t treat Dad’s IRA as her own, so during her lifetime she will get only part of the payout from Dad’s IRA. And payments to the other beneficiaries will be made over Mom’s life expectancy.
Ted named his niece and his favorite charity as equal beneficiaries of his IRA. Ted died at age 69 this year. If the charity’s interest in the IRA is paid out in full before September 30 of next year, the niece’s share of the IRA can then be paid out over her life expectancy. Otherwise, the niece’s share will have to be paid out no later than the end of the year containing the fifth anniversary of Ted’s death.
Note, however, that the rules for inherited IRAs are complex and that such IRAs may have other tax implications that must be considered, such as estate taxes.
Source: Thompson Reuters/Checkpoint
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