Underneath the volatility we have seen in 2018 we are seeing greater dispersion in the returns of the various asset classes. UK and overseas shares, bonds, government securities, property, commodities, infrastructure, hedge funds and so on are all performing differently to what we would normally expect at this stage in the economic cycle. The large firms of investment managers and banks will tell you ad nauseum that, “past performance is not a guide to future returns” and then go on to talk at great length about how this or that investment has performed really well over the past 12 months and why this means that you should invest some of your hard-earned capital there. The more successful observers take a more intelligent approach to history.
Practically all those who have studied economics over the past 30 years believe that it is the government’s function to stimulate the economy out of a recession. Modern governments, whether elected or command controlled like China, have translated this into job creation. Increasingly, leaders are becoming frustrated with their inability to get their economies (people) to comply with their desires. Part of the problem is that their chosen way of implementation, the central bank, has not been as effective as hoped. The institution that studies the central banks with the most detail is perhaps The Bank for International Settlements (BIS). The head of the BIS’s Economics-Research Department was recently quoted as saying, “politicians have come to rely on central banks to stimulate growth since the financial crisis of 2008.” Yet economies all round the world have produced below-average results in the past decade, so clearly something is not working.
Central banks like the Bank of England and the Federal Reserve in America have indeed kept interest rates at rock bottom levels for ten years, but the main effect of that policy has been the misallocation of scarce resources. Far too many people have continued to be employed by failing organizations kept alive only by ultra-low levels of debt repayment, instead of transferring that human capital to more profitable and sustainable activities. The more people and businesses who recognize the fact that governments are attempting to manipulate them, the lower their confidence in their own ability will be to build their own futures. You can see this phenomenon on TV every day when the populous, especially young people, are asked for their opinions on a matter of grave concern such as what President Trump said this morning on Twitter, or if we should give another £100 billion to the NHS (people not profit), they all seem to expect the Government to do something or make available another pile of cash from its unlimited stocks hidden in the basement of number 11 Downing Street. After all, it’s only fair.
We have been pondering on the suitability of our current investment strategy in response to the relative ineffectiveness of the top down thinking of central authorities around the world. The following issues should be considered by all financial advisers who take responsibility for looking after clients (and their eventual beneficiaries).
Firstly, will the coming recession be caused by cyclical or structural causes? The economy tends to move in cycles rather like a wave, sometimes rising and then falling, so a cyclical recession is when there is a downturn in economic activity. These are perfectly normal and are to be expected every seven to ten years or so. We know how to play the cyclical game, which is mostly based on sell/hold/buy decisions in the same funds. A structural recession is not due to cyclical reasons, rather it is down to structural problems (inferior education, lack of public transport, worn out infrastructure, corrupt government officials, poor public health etc.) that may differ from country to country. Typically, a cyclical recession is shorter because asset prices can adapt quickly. A structural recession involves the transfer of productive resources from one sector and location to another. This raises the question as to how quickly critical employees can be found and trained, not only in manufacturing but also in sales and service roles.
Secondly, how much of our economic and personal lives will be disrupted by the new technology? China will likely be the leader in the brave new world of data management, just like Saudi Arabia was in a world run on oil. It is quite conceivable that, at some point in the future, the Chinese military could surpass the US capability to an extent that could be extremely upsetting to the US. This is a more important concern for America than the loss of manufacturing jobs.
Thirdly, how will healthcare services in each country or region cope with the vastly increasing demands placed upon them? Global healthcare companies and products should, in our opinion, represent a reasonable percentage of the investment in many clients’ portfolios. To illustrate this point, let’s look at some of the issues surrounding the US healthcare system and indicate why we are positive on the outlook for a number of our fund holdings in this sector.
In 2017 it is estimated that US healthcare spending represented around 18% of US Gross Domestic Product, the total wealth of the nation. This is the highest anywhere in the world. Most developed countries spend around 10% of GDP on healthcare. This high and growing figure is a major political issue, as affordability is a mounting concern, coupled with the realisation that, despite this enormous spending, the US has the lowest life expectancy and highest infant mortality rates of any developed country.
The US healthcare system is unlike most others, particularly European, with citizens responsible for their own healthcare provision unless they are either poor (Medicaid) or elderly (Medicare). The consequence of this has been the development of a private health insurance industry that effectively underwrites an individual’s risk and offers anything from catastrophic coverage for only major illness through to comprehensive coverage for any illness. It is a market dominated by employer payers and, historically, employers included the cost of health insurance for their employees and their families as part of total remuneration.
The US healthcare system has largely operated as a “fee-for-service” industry, with every action undertaken within healthcare largely seen as discrete and reimbursed as such. An example would be a patient who presents to his doctor with chest pain: the appointment at the physician would represent a chargeable event, as would any diagnostic tests that are ordered. Should this lead to further investigation such as an MRI this would also be separately chargeable and finally should it be determined that the patient needs an operation (for example a stent to open a blocked artery) this would be charged in addition as would any medications required. If the patient were also morbidly obese, this would be treated as a totally separate condition.
Such a system encourages the overordering of diagnostic tests, over prescribing of drugs and the risk of performing interventions that are not always necessary. In many ways, US healthcare is like asking the barber if you need a haircut. Partly as a consequence of the system and partly due to other factors such as innovative procedures and new drugs becoming available, over the past two decades US healthcare costs have increased much faster than GDP. This has led employers to seek ways to reduce their costs typically through either removing or significantly reducing coverage and increasing the proportion that the employee has to pay. There is a growing awareness that, despite the high cost of healthcare to the US, outcomes are often worse than lower-cost healthcare models.
Cognizant of inefficiencies in the systems and disruption potential, new entrants are looking to better utilise data, analytics and technology to reduce the costs of healthcare. One such high profile entrant is Amazon, which appears to be on the verge of deploying its skills in distribution and logistics to the prescription drug supply chain. Also, high profile is the joint venture between Berkshire Hathaway (the company run by the world’s greatest living investor, Warren Buffett), JP Morgan and Amazon which aims to develop an alternative healthcare delivery model.
The best way to save costs in the US healthcare system would be to keep patients healthy and out of hospital. Better health can be achieved via many routes including better diet, more exercise, improved sleep and a reduction in the use of socially acceptable drugs such as marijuana, but these simple changes have all proved impossible to achieve. Earlier diagnosis of conditions is also hugely important, as is keeping chronic conditions under control by ensuring that patients take their medicines.
Healthcare providers in the future should be incentivised to keep patients healthy and out of hospital, rather than simply treating them for whatever they present at the physician’s office with. This requires an holistic view of a person’s health together with good data and analytics which can be used for preventative intervention and to determine the optimum treatment programme for every patient. A good example of the problem is hypertension. Around 30% of US adults suffer from hypertension but only 40% of those have it under control. The cost of hypertension to the US is estimated at more than $50bn annually and yet it is relatively easy and cheap to treat with drugs. The majority of the $50bn cost comes from the patient population that do not have their hypertension under control and present at the emergency room when their health rapidly deteriorates. This is clearly not efficient.
Obesity is yet another example – obese patients typically end up being extremely costly to the healthcare system due to comorbidities such as diabetes, renal disease, heart disease etc. It is estimated that around 35% of Medicare enrolees are obese and on average cost $2,000 more per year than an average weight individual. If these patients’ weight could be better controlled at an earlier stage, then costs in the future would fall dramatically. Unfortunately, under a fee-for-service system there is little incentive for an insurer, physician (or the NHS) to reach out to the patient early. Once healthcare moves to a value-based system, which it will have to do all over the world in the foreseeable future, there will then be much greater focus on the quality of care and outcomes. More focus as well on collaboration rather than volumes and outcomes rather than outputs. Care providers will be rightly incentivised to spot potential problems early rather than waiting for them to show up in the emergency room.
Given these pressures, why would we be considering choosing fund managers with holdings in these areas? Well, to quote the current US Health Secretary, Alex M. Azar, speaking earlier this year: “There is no turning back to an unsustainable system that pays for procedures rather than value. In fact, the only option is to charge forward – for us to take bolder action and for providers and payers to join us. This administration and this President are not interested in incremental steps. We are unafraid of disrupting existing arrangements simply because they’re backed by powerful special interests.”
The funds we have selected represent an answer to the issues rather than representing the problem. Our favoured funds invest a percentage of their capital in individual companies which are embracing the idea of providing better, more co-ordinated healthcare for lower cost. They each have attributes which are related to data management, the new gold standard and the management at the companies understand the problems and are able to position themselves appropriately for the future. We believe that the fund management teams we utilise understand the issues well and will be able to generate great returns over the coming years for patient investors.
In the meantime, we should expect continued volatility in the near term as Brexit rumbles on and the tensions caused by the trade war between China and the US rise inexorably until one side or the other backs down, but this is all froth really and it won’t be long before the beauty and rewards of investing in real businesses with real profits comes back into fashion. Our investment propositions have proved themselves to be highly resilient this year and ultimately, we believe that this will lead to higher returns.