GLP-1 Drugs and Healthcare Disruptors

A Wave of Enthusiasm for GLP-1 Drugs

Over the past several months, investors have enthusiastically embraced the potential of new GLP-1 therapies, such as Novo-Nordisk’s Wegovy & Ozempic and Eli Lilly’s Mounjaro.

While these products are currently billed as best-in-class treatments for weight-loss and Type II diabetes, new clinical data has demonstrated their potential in preventing and/or treating many chronic conditions – such as sleep apnea, kidney disease, cardiovascular conditions, orthopedic pain, and addiction disorders.

The ongoing GLP-1 fervor has triggered unprecedented underperformance for the Medical Device sector, and by association, Biotechnology as well. The near-term concern is that patients could theoretically cancel an upcoming surgery or medication, and alternatively, treat their underlying condition with an injectable GLP-1 drug (e.g., maybe I can avoid knee surgery if I lose 50 pounds). Longer-term, investors are also fearful that the prevalence of many chronic conditions could decline with the launch of these “wonder drugs”.

Current research indicates that GLP-1 drugs have had no near-term impact on surgery volumes. Longer term, while we acknowledge the potential for slower growth in weight-related end markets, adoption rates of GLP-1 therapies would need to double current consensus expectations to trigger a material decline in these populations.

Signs of a Bubble

Over the past several months, investors have flocked to GLP-1 stocks at the expense of nearly every other sub-sector of healthcare. We believe expectations here are lofty, with names such as Eli Lilly having traded at 16x 2024 consensus sales and 49x 2024 consensus earnings.

While we understand that rampant GLP-1 adoption is a theoretical long-term threat (potential cure) for many chronic conditions – we believe the hypothesized impact to the healthcare industry is overblown. A couple of points to counter the current narrative:

1. Based on our industry work, reimbursement authorities cannot support overnight access to these costly drugs (at an estimated cost of $1,000 per patient per month). As such, near-term eligibility restrictions are likely to restrain the ramp in GLP-1 treatments.

2. Additionally, many Americans have a natural aversion to injectable medications. Because these self-administered medications involve long needles to the stomach, we believe adoption rates will be measured.

3. Most important, GLP-1 drugs trigger appetite suppression through mechanisms of nausea, vomiting, and diarrhea – long-term side effects that many would consider intolerable. With more than 50% of GLP-1 patients dropping off the drug within 12 months (and regaining weight), this represents a significant headwind for impacting long-term medical outcomes.

Impact on Performance

The Medical Device sector has been decimated by the current GLP-1 narrative – with the S&P Healthcare Equipment Index down more than 20% in 3Q23 and another 9% in the first half of October. Biotechnology stocks have experienced a similar impact – with the S&P Biotechnology Index off more than 12% in 3Q23 and another 4% in the first half of October.

With more than two-thirds of the New Capital Healthcare Disruptors Fund allocated to Medical Devices and Biotechnology, the current environment has been challenging to say the least. Fund performance was down 8% in 3Q23 and another 5% in the first half of October. Full year performance is now flat YTD but outpacing the MSCI Healthcare Index by 250bps and our secondary benchmark (Solactive) by more than 850bps. The Secondary benchmark is designed to compare the performance of the fund with small and mid-cap companies, whereas the MSCI Health index tilts towards large-cap names.

Past performance is not necessarily a guide to the future. The value of your investments and the income from them may fall as well as rise as a result of market as well as currency fluctuations and you may not get back the full amount invested. Fund performance is net of fees and representative of the USD I Acc Share Class and shows a maximum of five previous calendar years and current year to date (computed on a NAV to NAV basis). Where share class inception begins prior to the five previous years the chart has been rebased to 100. Where the Fund has fewer than five full years of performance, returns are shown from the inception date. Benchmark: MSCI World Health Care Net Total Return USD Index, Secondary Benchmark: Solactive Developed Markets Healthcare Mid & Small Cap Index NTR. Source: EFG Asset Management, Bloomberg. As at 30 September 2023.

We believe the recent pullback is reminiscent of the bariatric surgery bubble of the early 2000s, as the procedure held the promise of 30% weight loss and a theoretical cure for Type II diabetes. And while the Medical Device and Biotechnology sector sold off in a similar fashion, many of these stocks experienced significant rallies as the procedure ultimately failed to quash the prevalence of weight-related disorders.

We Remain Constructive on Healthcare Disruptors

We believe the recent sell-off could represent an opportunity for us to establish or add to positions in the fund. Despite an attractive insular growth outlook, valuation multiples in both Medical Devices and Biotechnology have dropped more than one standard deviation below their long-term averages. For our fund specifically, the forward sales multiple has declined more than 38% since the start of the year.

While we have a few names that have been directly impacted by the recent GLP-1 fervor (e.g., Dexcom, Intuitive Surgical and Shockwave Medical), the bulk of our portfolio is focused on next-generation diagnostics and breakthrough treatments that are unaffected by the potential fluctuations of the “waistlines” in the developed world.

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