The long-term case for health care

The health care sector has underperformed compared to the broader market, delivering an 18% return over two years against the MSCI World Index's 49%. This underperformance highlights the sector's challenges, including COVID-19's cyclical impact, rising costs, fragmented supply chains, and funding weaknesses, particularly in China. Despite these hurdles, the sector exhibits strong long-term potential due to its high-quality characteristics such as return on operating capital employed (ROOCE) and gross margin, alongside stable earnings growth.

However, certain sub-sectors, like pharmaceuticals and biotech, face risks from patent expirations and single product dependency, which can lead to drastic revenue declines. This makes it challenging to maintain long-term confidence in these areas. Instead, the focus shifts to companies with recurring revenue models and low supplier-switching incentives, such as those providing diagnostic tests or infection prevention services.

Global animal health emerges as an attractive market, largely free from the patent and concentration risks seen in pharmaceuticals. This sector benefits from resilient demand and low generic penetration, making it a promising avenue for investment. Additionally, large diversified health care entities, such as major U.S. health insurers, leverage scale and network effects to compound growth effectively.

Overall, while the broader market faces high valuations and potential risks, health care investments anchored in quality and reasonable valuations offer steady compounding and resilience. These attributes have historically supported consistent performance in challenging economic environments, positioning health care as a viable long-term investment choice.