Summary

• Positive clinical data and M&A activity picked up in the sector. We saw more signs that the deal window may be reopening. The Senate version of the reconciliation bill included deeper cuts to Medicaid than the House version.
• The fund had strong results in dollar terms and relative to the broader healthcare sector but was down in absolute terms in the EUR-denominated share classes. Biotechnology contributed to results and broke a negative trend. The short book generated positive alpha during the month.
• The structure of the Most Favored Nation (MFN) provision and the future of pharmaceutical tariffs remained “known unknowns” and overhangs for the sector. However, the question is of when, not if, uncertainty abates.

Monthly comment

June was a month of contrasts. It began on a positive note but was marked by a lack of follow-through as generalists continued to shun the sector. Political headlines, positioning into second quarter earnings, and clinical data from two major medical conferences dominated the news flow during the month.

Positive clinical data is the lifeblood of the biotech industry

During the month, two large annual medical conferences took place. ASCO and ADA are conferences where experts share breakthroughs and discuss treatment trends in oncology and diabetes. More recently, ADA has also become an important forum for obesity discussions given the interplay between obesity and diabetes treatment. This year the discussions at ADA broadened beyond a previously more singular focus on GLP-1 therapies, with growing attention being directed toward products outside of this class. Several of our portfolio companies released positive data at ASCO. The therapeutic areas included Nontuberculous Mycobacteria (NTM) lung disease, HIV, multiple myeloma, lung cancer and opioid dependence. This array of positive clinical data underscored the continued innovation in the sector, addressing significant unmet medical needs.

M&A activity picked up during the month

There were signs of improvement in M&A activity during the month. Among others, Sanofi announced its intention to acquire Blueprint Medicines for $9.5 billion. Moreover, AbbVie, Eli Lilly and BioNTech all announced deals in the $1-2 billion range. The large pharmaceutical companies face patent expirations worth over $180 billion by 2030 (by comparison, the previous five years saw $90 billion in expirations). This creates an inherent need to complement the internal R&D pipeline with inorganic growth.

When political uncertainty abates and interest rates come down (as they most probably will), the bid/ask spread should further narrow, and the deal window should gradually open wider. Biotech valuations currently remain at historical lows, with a record number of companies trading at negative enterprise value. In other words, companies’ cash at hand is greater than market capitalization plus debt.

The Senate bill includes deeper Medicaid cuts than the House of Representatives

By the narrowest possible margin (51-50), the Senate passed a revised version of Trump’s signature law, colloquially called ‘‘One Big Beautiful Bill’. Both chambers of Congress must now reconcile their differences and agree on a common version of the bill. The Senate-passed version includes steeper cuts to Medicaid than the House’s counterpart.

Medicaid provides healthcare for the disabled and poor, and the Senate is looking to cut $1 trillion from the program over the next ten years. The House’s version sought to cut “only” $860 billion over the same period. The Senate’s more substantial reductions to Medicaid — the key reason behind Senator Tillis (NC) breaking party lines with the bill — are likely to increase pressure on Republicans in competitive districts in upcoming midterm elections. Meanwhile, members of the Freedom Caucus were frustrated that the Senate version would widen the deficit more than the bill passed by the House, mainly due to larger proposed tax cuts.

The most important healthcare-related incremental difference between the two bills is that the Senate is looking to lower provider taxes from 6 percent to 3.5 percent by 2032. This is a departure from the House-passed bill, which sought to lower federal costs by freezing states’ provider taxes at current rates, and prohibiting them from establishing new provider taxes. The timeline of implementation will most probably be pushed out by one year from the initial Republican proposal, a silver lining for the hospital lobby.

Reflections

June offered some glimmers of hope but was also something of a frustrating month. Healthcare is the sector in which mutual funds are the most underweight, by almost the same amount that they are overweight in technology stocks according to data compiled by Barclays.

To put this into perspective, the past quarter saw the worst relative performance for US healthcare stocks compared to the overall market in over 30 years. Moreover, the US dollar had its weakest first half-year in over 50 years. Tariffs, trade policy uncertainty and a ballooning US budget deficit undermined confidence in the dollar as a “safe haven” asset and questioned its role as a reserve currency. Setting the relative discussion aside, there of course remains a potential scenario of weaker absolute stock market performance due to a softer economy this fall.

Three big overhangs remain unanswered

Why this underperformance, you ask? Arguably, the three most pressing overhangs for the healthcare sector remain; the MFN drug pricing proposal, (potential) pharmaceutical tariffs, and disruption at the FDA.

Most Favored Nation

In May, the Administration announced its ambition to implement an MFN drug pricing proposal aimed at lowering US drug prices by tying prices for certain drugs to the lowest price paid in a reference country. So far, details have been scarce and there remains a high degree of uncertainty around both the implementation framework and the scope of drugs in the Administration’s MFN proposal.

As regards the implementation framework, there are several potential pathways. MFN could be implemented through Congressional action, or through a CMMI pilot program (CMMI is an organization within CMS), or within IRA drug negotiations (which might also require congressional action). Given the lack of support for MFN in Congress, we believe the most likely way to implement MFN would be through a CMMI pilot program. A CMMI pilot program is a method for Medicare and Medicaid’s Innovation Center to try out a new way of paying for or delivering care. Pilot programs can last for several years before being discontinued, expanded or codified.

This then raises questions about the scope. Would it target Medicare Part B, D or both? How would Medicaid be impacted? What might the downstream effects on commercial insurance markets be? These questions are very difficult to speculate on.

Precedents set in earlier CMMI models tell us that models with broader inclusion criteria are less likely to be implemented and approved. In other words, the narrower the scope, the bigger chance of getting implemented. Moreover, as stated in section 1115A in the Social Security Act, CMMI pilot programs are prohibited from reducing the quality of, and/or access to, care. This could potentially open the door for legal challenges from pharmaceutical companies if and when deteriorating economics stops pharmacies and hospitals from making drugs available over time, thus reducing access. So, there remains a possibility that MFN might never see the light of day.

If MFN became a reality though, our view is that the impact would be meaningful. Depending on mitigation measures, such as increasing drug prices outside of the US, cutting operating expenses, opting out of countries with particularly low prices, the commercial market taking more volume from Medicare over time, estimates of the impact of MFN vary. A 10-30 percent impact on earnings if and when MFN is fully phased in (which could take 5 years or more) is reasonable in our opinion (but also hypothetical). This seems to be more than reflected in current stock prices for large pharmaceutical companies, even if the impact from (potential) 20 percent sector-specific tariffs is factored in.

Lastly, there have been vague threats from the Administration about using the FDA as a weapon to negotiate prices with pharmaceutical companies directly; threatening to not approve new drugs if companies do not lower their prices. This would, however, most likely be illegal and most certainly be (successfully) challenged in the courts. We see only a very low risk of the Administration going down this road.

Valuations compelling

We still believe that the best days for biotech and pharma are yet to come. The sector offers superior growth potential, a free cashflow profile, and is currently trading at a steep discount to the broader market (16.1x NTM P/E for MSCI Healthcare versus 19.7x NTM P/E for MSCI World). Dislocations have happened before, albeit never to this extent (2008 being the closest analogy) and have importantly always corrected themselves over time. We are convinced… this too shall pass.