Healthcare costs are escalating and for patients, those expenses seem to reach new heights in the operating room. A new generation of sophisticated, high-tech gadgets, machines and even robots are among the reasons surgery costs are soaring.
There are multiple benefits to the increasing intersection of healthcare and technology. Surgical innovation reduces risks for patients, pares recovery times, lowers in-surgery complications and reduces post-operation pain and scarring. Investors can tap into healthcare evolution, too, but properly accessing the investment potential of rising operating costs requires a discerning eye.
Said another way, a large- or mega-cap healthcare stock or diversified sector index fund may lack adequate exposure to dedicated medical device manufacturers, the very segment of the market investors should look to as an avenue for tapping rising surgical costs.
For example, Johnson & Johnson (JNJ) has a large medical devices business, but in the second quarter, that unit accounted for just $6.48 billion of the company's $20.56 billion in revenue. Likewise, medical device manufacturers and healthcare equipment makers represent just over a quarter of the S&P 500 Health Care Index compared to 32 percent for pharmaceuticals stocks.
Ideas for accessing a basket of medical equipment stocks in a passively managed wrapper include the iShares U.S. Medical Devices ETF (IHI), the largest exchange traded fund (ETF) dedicated to this industry. As the chart below indicates, IHI has been the clear winner over the past three years among iShares' diversified and healthcare industry ETFs. During that time, IHI sharply outperformed biotechnology, healthcare providers and pharmaceuticals ETFs.
Courtesy: ETFreplay.com
A Thesis Underpinned By Growth
Rapidly aging populations in the U.S. and other large markets, including China, Europe and Japan, provide a positive demographic tailwind for medical device makers. Those aging populations are rising tides that could lift the boats of medical equipment stocks. Data confirm that growth is underway.
“Global market of operating room equipment surpassed a value of US$ 29 billion in 2018, and is likely to record a Y-o-Y growth of 6.0% in 2019,” according to a recent Fact.MR study . “Key factors impacting the growth of global operating room equipment market range from surging prevalence of pathological and physiological diseases to growing preference for minimally invasive and non-invasive surgical procedures.”
Several of IHI's 57 components, many of which are classified as large-cap growth stocks in the Morningstar style box, are reflecting the robust growth prospects of the medical devices industry. Recently, Abbott Laboratories (ABT) , IHI's largest holding, said second-quarter medical device sales notched second-quarter organic growth of 10.5 percent.
Thermo Fisher Scientific Inc. (TMO), IHI's third-largest holding, said second-quarter sales across its four primary units, Life Sciences Solutions, Analytical Instruments, Specialty Diagnostics and Laboratory Products and Services, increased, prompting the company to boost its 2019 revenue forecast to $25.30 billion to $25.50 billion from original guidance of $25.17 billion to $25.47 billion.
Fair Exchange
Often times, investing in a growth segment, particularly one involving healthcare or technology, means accepting more volatility, but that is not the case with IHI. The fund's risk-adjusted returns over the past three years are superior to those of other iShares healthcare industry funds and, as the chart below indicates, IHI's maximum drawdown during that period was lower than competing, biotechnology, healthcare providers and pharmaceuticals funds.
Courtesy: ETFreplay.com
While IHI isn't as volatile as many tech/growth investments, assigning the growth label to the fund is relevant because of underlying market trends. Operating rooms account for about $6 of every $10 in revenue generated by hospitals. Healthcare facilities can bolster that revenue stream with enhanced technology and it is expected that U.S. hospitals will spend hundreds of billions dollars over the next decade on safer, more efficient medical equipment and surgical devices.
Related: Investing in Healthcare Technology and Innovation