October was a challenging month for the fund, with concerns about the prospect of a Clinton victory in the US presidential elections weighing negatively on sentiment towards health care stocks. At the same time, the month saw a significant rotation into parts of the market to which the fund is not exposed, including banks and commodity-based stocks. This environment saw the fund’s net asset value decline modestly, even though the FTSE All Share index posted a small positive return.
Unsurprisingly, given the negative sentiment, the fund’s pharmaceutical and biotechnology holdings were among the main detractors from performance. These included AstraZeneca whose shares fell towards the end of the month after adverse effects related to bleeding prompted the suspension of patient enrolment for its late-stage trials for head and neck cancer treatments. The market seemed worried about the possible implications this could have for the highly anticipated Mystic trial, the results of which are expected to read-out in the first half of next year. We do not share the market’s concern however, as the treatments are for completely different types of cancer and it is unlikely that there is a valid read-across. We remain confident that AstraZeneca’s innovative drug pipeline is well-placed to create substantial long-term value and added to the holding towards the end of the month.
Elsewhere in the sector, GlaxoSmithKline saw its shares weaken despite releasing very strong third-quarter results that exceeded market expectations by a substantial margin. Theravance Biopharma also performed poorly with its shares declining in response to a further equity offering. In our view, this fundraising is a long-term positive for the business as it gives it more capital to further progress its rapidly developing pipeline. We recently met its management team for an update on the company’s progress and the news coming out of the business is even better than we had previously thought. We continue to view Theravance Biopharma’s long-term prospects as extremely attractive.
Alkermes, however, bucked the general weakness in biotech and saw its shares surge on some very positive clinical data from its FORWARD 5 trial for ALKS 5461 – the company’s potential blockbuster treatment for major depressive disorder. The success follows earlier trial disappointments that saw Alkermes’ market cap more than halve in January this year. Nevertheless, the company retained confidence in ALKS-5461 at the time and this latest data represents an important step towards the commercialisation of an asset that the market had all but written off.
Meanwhile, Burford Capital also made a notable contribution to performance. The company specialises in litigation finance and has a strong track record of backing the right legal cases. During the month, it announced that it had opened its own law firm, which will provide an important in-house resource that should enhance its long-term prospects even further. A further positive was Utilitywise, which reported strong full-year results, alleviating the market’s concerns about the gap between its earnings and cash flow, which the company is working hard to reduce.
Elsewhere in the portfolio, tobacco delivered mixed returns during the month, in response to British American Tobacco’s proposed deal to acquire the remainder of Reynolds American. This news was greeted by an immediate spike in Reynolds’ share price to an all-time high to reflect the terms of the deal. Shares in BAT weakened, however, despite the attractiveness of the proposal for its shareholders. This had more to do with the activities of risk arb funds and the market’s pre-occupation with resources and financials, than an adverse interpretation of the commercial characteristics of the deal. Our view is that this deal was inevitable and, although it has happened earlier than we thought, makes a lot of strategic and financial sense. We will be voting in favour of the transaction.
The positive share price reaction in Reynolds American gave us the opportunity to sell the remainder of the fund’s position in the company at a very attractive price. BAT already owns 42% of Reynolds, so we retain indirect exposure to the business. We added to the positions in BAT and Imperial Brands, with the proceeds of the Reynolds sale.
Elsewhere in terms of portfolio activity, Roche was sold from the portfolio in the ongoing fight for capital, and we increased positions in several companies including Capita, Provident Financial, Lancashire and Paypoint. We also introduced two new unquoted biotech companies: AMO Pharma, which is developing therapies for serious and debilitating orphan diseases and Precision Biopsy, which is developing an intelligent biopsy technology to aid cancer diagnosis and which we’ve held in the Woodford Patient Capital Trust for some time now.
The other important strategy development during the month concerns currency. The recent weakness in sterling has led us to consider at what level we should hedge the portfolio’s US dollar exposure. For some time, we have been anticipating sterling weakness and broadly, this played out as we expected following the Brexit vote. The portfolio has therefore benefited from being unhedged in the period since launch, but we now believe that the weakness in sterling has gone far enough and so hedges were introduced against all remaining foreign currency exposures towards the end of the month. As with all investment decisions, this reflects a long-term view – we have no insight into what will happen to sterling on a three-month view, but on a three-to-five-year view, we no longer expect further material weakness in the domestic currency.
Looking forward, the surprise result of the US presidential election has removed some of the clouds that were hanging over the health care sector from a market sentiment perspective. Fundamentally, we did not believe that a Clinton presidency would undermine the long-term investment case for health care but the Trump victory has certainly improved sentiment towards the sector. Longer-term, we remain convinced that there are structural growth drivers for the global health care industry and we have found some very attractive and genuinely innovative and disruptive companies in which to invest.
More broadly, we don’t believe that the outcome of the US election dramatically changes the outlook for the US economy. We don’t see recession as a likely scenario but nor are we getting too excited about the prospect of a dramatic improvement in US economic growth. The market has seized upon plans for an infrastructure-led fiscal stimulus as a reason to sell US Treasuries and buy sectors that would benefit from more government spending, but we think it would be wrong to get carried away with this prospect. At the margin, a Trump presidency probably does mean more spending on infrastructure but this needs to be seen in the context of an already highly constrained fiscal position and some elements of the Republican Party that will be very resistant to fiscal stimulus and/or tax cuts.
‘Campaign in poetry, govern in prose’, as the saying goes and whilst it’s difficult to describe anything that we heard in the run-up to the election as poetry, the reality of a Trump presidency will likely be more moderate than was suggested by the campaign. In other words, not a lot has changed as far as the outlook for the US economy is concerned, nor indeed for our view of the global economy.
At the margin, risks have increased but our conclusion so far, is that the equity market has over-reacted to the Trump election win. We remain happy with the shape of the portfolio and confident in the prospect of attractive long-term returns.