Investing in health care innovation

Disruption in this historically stable sector is creating new investment opportunities.

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Key takeaways

  • The pandemic has accelerated disruption—and innovation—already underway in how health care is managed, delivered, and paid for in America.
  • Those transformative changes are creating investment opportunities in biotech as well as with drug makers and managed care providers.
  • Long considered a defensive sector, health care may now offer opportunities for growth investors too.
  • Structural reforms will also play a major role in health care's transformation.

The recent announcement that Johnson & Johnson (JNJ) will split itself into 2 companies, one focused on pharmaceuticals and devices and another on consumer health products, is only one sign of change taking place in the health care sector. Health care stocks have long been popular with investors seeking to immunize their portfolios against excessive volatility. But a wave of innovation, accelerated by COVID-19, is producing opportunities across the health care sector for growth-oriented investors as well.

Health care is ripe for disruption and transformation not only because of its huge size but also because of the size of the challenges that it faces. Each day in the US, 10,000 people reach age 65, and as people live longer, they need more health care services. Costs are also rising and the US already spends nearly twice as much per person as other developed countries without appreciably better health outcomes. In addition, the relationships between those who provide care and those who pay for it are shifting as insurance companies and employers seek to shift more responsibility to health care consumers and governments face increasing pressure to "do something" to expand coverage and control costs.

Technological disruption

Eddie Yoon, who manages Fidelity® Select Health Care Portfolio (FSPHX), says the need to meet these challenges is driving innovation. "We are in the early innings of structural transformation in the largest health care market in the world—the United States' $4 trillion health care economy. Winners and losers will emerge, and the pandemic has accelerated the pace of change," he says.

Yoon believes the pandemic will help speed that transformation. "The next focus for many biotech firms, drug makers, and services providers will be to leverage innovations and lessons learned during the pandemic to solve other big health care problems," he says.

Fidelity biotech analyst Eirene Kontopoulos says RNAi , or ribonucleic acid interference therapy, is an example of a technology with disruptive potential. RNAi is an innovative class of medicines that can interfere with the production of aberrant proteins that either cause or contribute to diseases. Kontopoulos says several of these treatments are showing impressive success in clinical settings. "I see RNAi therapeutics as one of the most promising and rapidly advancing frontiers in drug development."

Drugs based on RNAi are designed to address the underlying mechanism of a disease by binding to a patient's RNA and blocking the production of disease-causing proteins, ultimately acting upstream of traditional therapies that come into play during later steps of the disease's progression. Because RNAi works with the body's natural processes, Kontopoulos says it has the potential to deliver effective clinical results, often greater safety and, in some cases, more predictability compared with many other chemical and genetic treatment approaches.

RNAi technology is being used to develop potential treatments for hypertension, hepatitis B, and liver disease. Hypertension, or high blood pressure, affects some 60 million patients in the US alone, and is highly predictive of future cardiovascular events such as heart attacks.

In addition to drug makers and biotechnology firms, Yoon says medical device companies are also sources of potentially disruptive innovation. Historically, medical equipment makers have had highly durable, stable-growth businesses, but some are increasingly innovators as well. For example, Penumbra (PEN), has seen improved sales of its Indigo® Aspiration System which is used to remove blood clots, and the firm is also working on innovative new products such as a virtual reality-based therapy to help patients recover from strokes.

Managing disruption

While technological innovations have the potential to bring down costs and improve outcomes, companies that focus on delivery and payment of care also have a significant potential role to play in transforming health care. Yoon says managed care providers such as UnitedHealth Group (UNH) and Humana (HUM) continue to emphasize taking costs out of the system for patients and providers, even as they face rising short-term costs as more patients return to doctors' offices for routine care and previously delayed procedures. Yoon believes value-based care is here to stay, and will fundamentally transform the US health care economy over the next decade. He expects to see long-term winners and losers with this generational change.

Yoon also expects additional government spending on public health, including pandemic preparedness, infectious disease awareness, and a deeper, more robust global supply chain. This could benefit Danaher (DHR), which Yoon cites as helping to fill gaps in US testing and bioproduction capacity. "We need to fix the inherent weaknesses in the health care delivery system and the shortage of capacity in the US drug-supply chain, and I'm already looking for the companies I think will help address these issues," he says.

Fidelity® Select Health Care Portfolio held securities mentioned in this article as of its most recent holdings disclosure. For specific fund information, including holdings, please click on the fund trading symbols above.

Finding ideas

Those who want to invest in the future of health care should consider professionally managed mutual funds and ETFs. Fidelity has a number of tools to help investors screen through mutual funds and ETFs for research ideas. You can run screens yourself using the Mutual Fund or ETF screeners on Fidelity.com. Below are the results of some illustrative screens (these are not recommendations of Fidelity).

Fidelity funds

  • Fidelity® Select Health Care Portfolio (FSPHX)
  • Fidelity® Select Medical Technology and Devices Portfolio (FSMEX)
  • Fidelity® Select Pharmaceuticals Portfolio (FPHAX)

Non-Fidelity funds

  • Baron Health Care Fund Retail Shares (BHCFX)
  • T. Rowe Price Health Sciences Fund (PRHSX)
  • Putnam Global Health Care Fund (PHSTX)

Exchange traded funds

  • Invesco S&P 500® Equal Weight Health Care ETF (RYH)
  • iShares US Healthcare ETF (IYH)
  • SPDR® S&P Health Care Equipment ETF (XHE)

The Fidelity screeners are research tools provided to help self-directed investors evaluate these types of securities. The criteria and inputs entered are at the sole discretion of the user, and all screens or strategies with preselected criteria (including expert ones) are solely for the convenience of the user. Expert screeners are provided by independent companies not affiliated with Fidelity. Information supplied or obtained from these screeners is for informational purposes only and should not be considered investment advice or guidance, an offer of or a solicitation of an offer to buy or sell securities, or a recommendation or endorsement by Fidelity of any security or investment strategy. Fidelity does not endorse or adopt any particular investment strategy or approach to screening or evaluating stocks, preferred securities, exchange-traded products, or closed-end funds. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from its use. Determine which securities are right for you based on your investment objectives, risk tolerance, financial situation, and other individual factors, and reevaluate them on a periodic basis.

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