A Crisis of Opportunity: Why Tech & Healthcare Come Out on Top
Crises often exaggerate the differences between the weaknesses and the strengths of any system. As quality investors, it has been interesting in recent months to see the market reward those companies whose products or services genuinely offer solutions to mission-critical problems; those companies which can grow in the bad times as well as the good; and those companies with the humility and the discipline to have maintained healthy balance sheets in a decade of ‘loose money’.
Without wishing to diminish the significance of the difficulties and the challenges that the recent months have produced, we nevertheless see some interesting trends that we hope make for positive reading:
- A Robust Backdrop
Without making any macroeconomic predictions – this is not our style – it is reassuring to see that this is a crisis unlike others. Unlike 2008, there does not seem to be an underlying problem in the financial system. Quite the contrary, banks are unusually well capitalised. The savings rate has gone up, portending future demand growth. Governments and central banks have unleashed a level of both fiscal and monetary stimulus that has never been exercised before with such speed and in such synchronicity.
- A Glimpse of the Future: Winners and Losers
By stripping out everything in the economy that is not strictly necessary or needed, our time spent locked down ‘in the trenches’ exposed to society all the things which we cannot live without, as well as all the areas that perhaps we do not need as much as we thought.
We caught a glimpse of the future. Those industries which have long been in structural decline had their future flash before their eyes: segments of hospitality; the oil industry; cinemas; traditional high streets and physical retail, to name some examples.
Meanwhile, those industries that have long been experiencing structural growth saw a spike in the already increasing value which they contribute to the modern economy: communications technologies (Zoom, Sinch); cloud storage or digital transformation businesses (Amazon AWS, Reply); cyber-security companies (Qualys, Zscaler) ; online gaming companies; digital payments businesses (Adyen, Stripe); clean energy technologies (Solaredge, Tesla); life sciences research and diagnostics businesses (Biotage, Stratec, Diasorin). Just to be clear, we do not own all these companies.
Some technological disruptors have remarked in earnings calls that they are seeing what would otherwise be three to five-year growth journeys being crammed into a matter of months.
- Technology Works – and there is so much more to do!
We have seen that in our time of need, technology has genuinely helped. It works! Zoom calls work for remote meetings; enterprises can indeed scale their cloud environments and still handle unprecedented surges in data or transaction volumes; digital payments companies can successfully on-board customers in days and handle massive surges in volumes. And there are areas where clearly more work needs to be done. Clinical trials could benefit from more technological disruption, and better ways of analysing trial data. Banks could benefit from more packaged software and cloud technology as they struggled to manually process the millions of loan requests. Call centres could do with some more software automation to handle larger volumes more cost-efficiently.
But whichever way you look at it, the tremendous growth opportunities that we sought out before the crisis are not just here to stay – they now have a massive light shining on them. No wonder stock-pickers increased their exposure to the software sector from 5.1% at the beginning of the year to 6.4% (according to Copley Fund Research).
- Healthcare – Investment Needed!
Healthcare is an enormous sector. Governments spend more on healthcare as a portion of GDP than on any single other ‘sector’. Similarly, to many areas, Healthcare has seen a bifurcation between the disruptors and the disrupted. Those areas of structural growth have done enormously well: biologics equipment manufacturers like Sartorius Stedim Biotech; large molecule therapeutic manufacturers like Catalent or Samsung Biologics; Molecular Diagnostics players like Tecan and Illumina; drug discovery software like Simulations Plus – meanwhile areas that are providing less value and less innovation have fared far less favourably.
After the financial crisis, we realised that banks were over-stretched, optimised for short-term profits, and that a capital buffer was needed. Now, perhaps, we have realised that our healthcare practices were over-stretched, optimised to short-term demand, and that a ‘capacity buffer’ is needed. This bodes well for the entire sector over the coming years.
And another light has been shone on those areas where we need to improve. Cutting edge biotech funding is what allowed Moderna to produce a vaccine candidate within weeks using a completely new mRNA technology. But expect to also see more biotech funding in areas that are not quite as advanced as vaccines – antibiotics comes to mind. Molecular diagnostics is yet another area where we came up short on capacity.
- More Strategic Capital Allocation
The last trend may be a shift, both from governments and corporations, towards a model of capital allocation less geared towards short-term profit optimisation. Key areas of strategic infrastructure – from scientific research, to semiconductors, to 5G communications, to supply chains – need to be more heavily and patiently invested in. In some of these areas, the West has realised that there has been a level of outsourcing to China and other economies that has left it at a competitive disadvantage. Insourcing much of these supply chains and investing heavily in research could reallocate some of the unproductive capital and talent in the economy, triggering a renaissance in productivity numbers and growth. Will the ratio of invested capital to dividends and buybacks go up in 2021? One to watch.
What to make of it all?
We are seeing a sharper economic and industrial recovery from this particular crisis than some had anticipated. This is not to say that weaknesses in the system have not also bubbled up to the surface. But it is to say that we have unearthed a world of opportunity.
Facing pressure, companies have found it surprisingly easy to make productivity gains and reduce unnecessary costs; technologies that augment productivity and accelerate product innovation are in the spotlight and are attracting increased funding. Disciplined management teams with sound balance sheets are being rewarded with the strength to make investments for the future, at a time when some of their weaker competitors are having to cut costs. There are always winners and losers; but it seems increasingly likely that this crisis has brought about a storm of factors that could accelerate the fortunes of those high-quality companies solving genuine problems in areas of structural growth. Technology and Healthcare seem to be excellent focal points for a lot of this. Let’s see if 2021 paves the way for a year of real productivity gains and earnings growth for these top companies.