One of the most unfortunate certainties of life is that it ends. Fortunately pharmaceutical firms are working on life-saving treatments to improve our quality of life and hopefully extend it.

Investing in the pharma sector can be rewarding if a company develops the next big blockbuster drug but this journey is filled with risks, as we explain later.

In this article we explore how investors can gain exposure to companies that are battling some of the biggest diseases we currently face and the emerging threats that could impact our health.

WHAT ARE THE BIGGEST HEALTH THREATS?

In 2015, coronary heart disease and stroke remained the world’s biggest killers, accounting for a combined 15m deaths according to the World Health Organisation (WHO).

Coronary heart disease occurs when the heart’s blood supply is blocked by built-up fatty substances in the coronary arteries, which can cause heart attacks. Strokes happen when the blood supply to part of the brain is cut off, according to the NHS.

Other top causes of death include chronic obstructive pulmonary disease (COPD), lung cancer and diabetes, the latter of which can be caused by obesity. COPD is a progressive, life-threatening lung disease that is caused by tobacco smoke and air pollution.

CHOICES FOR INVESTORS

Investors have several options with regards to companies on the stock market, or funds investing in relevant companies, which are trying to battle the world’s biggest health risks.

These companies may all be trying to do positive things yet that doesn’t mean they will all make you money.

It is important to stress that pharmaceutical and biotechnology stocks are extremely high risk, particularly small cap stocks which may have to keep raising new money to fund their development work. Outcomes can be binary: treatments either work or they don’t, which can result in extreme share price volatility.

For this reason we believe it is important to take a diverse approach to investing in the sector, making sure you have exposure to a wide range of stocks, or use funds to achieve diversity, and not simply pin your hopes of investment success on just one or two stocks.

Some companies will only be developing treatments for a single disease; others will be working on treatments for different conditions. As such, it is always worth reading company literature to fully understand the opportunities and the risks before investing.

AN EXAMPLE OF A RELEVANT FUND

Investment trust Polar Capital Healthcare (PCGH) seeks to generate capital growth through a global portfolio of healthcare stocks. Interestingly its portfolio contains more than just drug companies as we will explain in a minute.

Fund manager Dan Mahony says investors interested in the broader field of healthcare should look at what a company is doing and their outlook, instead of focusing on what disease they are treating.

He argues people cannot ‘buy and forget’ a healthcare stock and flags potential disruption to the industry as technology evolves.

The convergence of technology and healthcare, known as digital health, is becoming significant in improving a patient’s quality of life by encouraging positive behaviour.

Technology is increasingly being used to detect health issues and encourage individuals to take preventative action before the situation worsens. That could boost demand for certain treatments and reduce demand for others. It is therefore important to keep on top of technological developments.

WHY DATA AND TECH SHOULD NOT BE OVERLOOKED

Research by the NHS finds that people who maintain a healthy weight with a body mass index of below 25 are less likely to become diabetic. Diabetes is linked with several fatal conditions, including strokes and coronary heart disease.

Mahony says insurers are tapping into these trends by including gym membership offers with policies.

He is excited about health insurance firm UnitedHealth, one of his top holdings, and Medicaid plan provider Centene.

These companies aim to innovate healthcare by focusing on value-based models that use data to explore health outcomes and the quality of care from medical providers to determine payments. It places more risk on hospitals, forcing them to improve quality of care and cut healthcare costs.

EXPOSURE TO US GIANTS

Among Polar Capital Healthcare’s top holdings are global giants in healthcare including Johnson & Johnson, Novartis and Bayer.

Among the UK pharma large caps, AstraZeneca (AZN) is a favourite of the fund manager who says its best-selling lung cancer drug Tagrisso is underestimated by investors.

In the year to 31 December 2017, sales of Tagrisso soared 126% to $955m.

On a group basis, AstraZeneca is working on returning to product sales growth by a ‘low to single-digit percentage increase’ by the end of 2018. That would represent the first growth in overall product sales in four years.

The company primarily specialises in development treatment of diseases in three areas: oncology, cardiovascular and renal/metabolism/respiratory.

INNOVATIVE SMALL CAPS

While the majority of Polar Capital Healthcare Trust’s exposure is in favour of large US companies, there are plenty of opportunities in the UK small cap space.

Included in the fund’s holdings are Consort Medical (CSRT), Summit Therapeutics (SUMM:AIM) and Verona Pharma (VRP:AIM).

The pharmaceutical sector is notoriously risky, but Mahony believes there are lower risk ways to gain exposure.

One of these is via Consort Medical, which works with global heavyweights to manufacture drug-delivery devices such as inhalers and auto injectors.

Consort Medical’s partner Mylan is hoping to launch its generic version of GlaxoSmithKline’s (GSK) blockbuster drug Advair Diskus later this year, providing potential earnings upside for Consort.

THE VALUE OF TREATING DISEASES EARLY

Over the last couple of years, there has been a bigger focus on detecting and treating diseases earlier to keep people healthier for longer.

Paul Major, fund manager at investment trust BB Healthcare (BBH), argues early diagnosis is a good approach to treating various diseases, particularly cancer.

‘The key to tackling cancer is not advancing treatments, but early diagnosis,’ comments Major, who highlights tumours can grow, break apart and rapidly spread.

BB Healthcare aims to provide investors with long-term capital growth and income by investing in firms working to diagnose conditions early or keep existing diseases in check.

Rare diseases specialist Shire (SHP) is the only UK-listed company to catch Major’s eye as its shares are cheap, trading on a mere 11-times forecast earnings for 2018.

Among BB Healthcare’s top holdings is gene sequencing specialist Illumina. Its products enable researchers to explore DNA and create a map of gene variations associated with health, disease and drug response.

Illumina says it now has the ability to sequence at an ‘unprecedented scale’. It adds: ‘Collectively, this will give us a much deeper understanding of genetics than ever before. We will begin to truly unlock the power of the genome. These advances will trigger a fundamental shift in healthcare and beyond. Medicine will continue to become more preventive and more precise.

Illumina’s spin-off company Grail is working on a blood test to detect cancer early before symptoms appear.

Grail wants to achieve this goal by looking for cancer DNA that could help find tumours, which can be cut out before they spread.

Major says early diagnosis of diseases improves treatment options and cuts healthcare costs, particularly important for healthcare systems like the NHS which are seeking innovative ways to increase performance at a lower cost. For example, treating lung cancer can cost $100,000 a year and is not a guaranteed cure.

The fund manager argues high drug prices in the US are not always justified as diagnosing cancer early means a treatment can be used in smaller doses for a more powerful response.

MANAGING COMPLICATIONS OF DIABETES

US-listed Dexcom is one of BB Healthcare’s top holdings; it manufactures glucose monitoring systems. These systems measure sugar levels under the skin and can predict your glucose levels, where they are going and how fast they are getting there.

A complication of diabetes is hypoglycaemia, where the level of glucose in your blood drops too low, which can be dangerous and result in hospitalisation if not treated promptly. Dexcom’s device can help avoid this by keeping glucose levels under control.

One of the ways to avoid hypoglycaemia is by keeping track of your blood sugar and helping low glucose levels by drinking a small sugary drink or having a snack.

WHICH FIRMS ARE HOPING TO TACKLE ALZHEIMER’S AND DIABETES?

Clinical-stage biopharma firm PureTech (PRTC) has developed the Akili technology platform which is used to understand attention deficit hyperactivity disorder (ADHD); although it could also be useful in predicting early Alzheimer’s to help with the symptoms.

The technology aims to improve memory and attention by helping the brain process multiple streams of information at once.

PureTech’s affiliate Sonde is developing a voice-based tech platform that can identify health issues, including depression and Parkinson’s disease based on vocal biomarkers. It hopes to expand the technology to detect cardiovascular and respiratory diseases to prevent people from getting ill.

Other products in the pipeline include obesity drug Gelesis and affiliate resTORbio’s novel therapeutics to treat ageing-related diseases.

WHO IS BATTLING IT OUT TO TREAT RESPIRATORY DISEASES?

In the respiratory diseases space, Circassia (CIR), Verona Pharma and Vectura (VEC) are hard at work trying to improve people’s lives.

Circassia markets COPD treatment Tudorza in the US under its collaboration with AstraZeneca, and holds US commercial rights to COPD therapy Duaklir.

The speciality pharma company is building a franchise in the COPD field by developing a novel formulation combination COPD treatment for infirm patients with severe symptoms.

Verona Pharma’s RPL-554 treatment aims to be more effective due to its anti-inflammatory action. In September 2017, the company reported positive top-line data from a Phase IIa trial on RPL-554.

RPL-554 hopes to add a meaningful improvement in lung function by consistently delivering higher doses of the drug to the lungs.

Device and formulation company Vectura reformulates drugs, puts them into devices and partners with other companies to license
the product.

It had a difficult time last year after generic asthma treatment VR315 by Hikma (HIK), which contained its dry power technology, was delayed by the FDA, the US regulator. This pushed back milestone and royalty payments from sales of the drug for Vectura as the launch of VR315 is now expected to be 2020.

The company currently generates sales from respiratory disease treatments Ultibro and Flutiform, which were developed with Novartis and Mundipharma respectively.

Vectura believes its strategy of ditching higher risk early stage novel molecule development is a positive step forward. The company says future partnerships with major companies and sales from licensed products should help its performance.

UPCOMING THREAT FROM ANTIBIOTIC RESISTANCE

In 2016, economist Lord Jim O’Neill warned the number of deaths associated with antibiotic resistance by 2050 will outstrip death from cancer and diabetes combined.

Destiny Pharma (DEST:AIM) is trying to develop a treatment for antibiotic-resistant superbugs such as MRSA. Its drug XF-73 is currently being tested with the aim of killing bacteria within 15 minutes. A US launch for the potential blockbuster drug has been scheduled for between 2020 and 2021.

WHAT ARE THE RISKS WITH INVESTING IN THIS SECTOR?

Development, financial and commercialisation risks are the biggest headwinds investors should consider before investing in any pharma company.

Investors need to look at the development risks and assess whether the treatment is likely to pass clinical trials. If a company cannot prove a drug works, it won’t be approved by the relevant healthcare authority and generate sales, essentially stunting any shot at profitability.

Recent examples of failed drug trials are AstraZeneca’s lung cancer trial in July 2017 and Circassia’s allergy trial, leading to a complete halt in investments for related programmes.

Typically there are three main clinical trials, Phase I, II and III – and they aren’t cheap. Getting a drug through clinical trials takes many years and can cost millions of dollars.

According to the US Department of Health, a Phase I trial can cost approximately $4.5m, rising to c$11m in Phase II, while Phase III trials can cost c$22m.

A key source of funding for listed companies is investors handing over cash in exchange for new shares. That dilutes existing shareholders and is a pattern that can be repeated on quite a regular basis.

WHY APPROVAL IS NOT ALWAYS GUARANTEED

Once a company has proven a drug is safe, there is still no guarantee that it will be approved. An example of this situation is the struggle by GlaxoSmithKline’s rivals in replicating its asthma treatment Advair Diskus.

In 2017, the US Food and Drug Administration blocked the launch of Mylan’s Wixela Inhub and Hikma’s VR315 drugs. Hikma has recently been forced to conduct a further clinical study into its treatment.

This has also dragged on the performance of Vectura which is responsible for the dry power technology for Hikma’s generic treatment.

It highlights the importance of understanding what a company is working on and how its partnerships can affect performance and outlook.

WHICH STOCKS OR FUNDS TO OWN?

Large companies tend to have growing sales from multiple franchises and a potentially innovative pipeline. However, they aren’t guaranteed to be good investments as large cap pharma stocks can still have setbacks.

Smaller firms may be considered as higher risk but they should not be overlooked. Successful ones can make the next big blockbuster drug or be taken over by a global giant looking to bolster its pipeline further.

Ultimately investors should aim for a diversified range of companies to help minimise the impact of any particular clinical trial failure, funding struggle and approval setback. You can either build up a portfolio of stocks or buy one or two relevant fund or investment trusts.

Three of our favourite stocks and funds to play the sector at present are AstraZeneca, Destiny Pharma and Polar Capital Healthcare. (LMJ)

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