The importance of active asset allocation; why the healthcare and infrastructure sectors are still key portfolio components in 2024
Both healthcare and infrastructure stocks had a mediocre 2022 and, for the most part, a difficult 2023. However, we believe the case for investment in both sectors remains almost entirely as strong as it was before the period of poor performance.
For investors, most of 2023 was deeply disappointing. This was unexpected because normally, after the steep falls in both equity and bond markets seen in 2022, you would expect a more robust recovery over the following year.
Whilst there was a positive recovery in both equity and bond markets in the last two months of 2023, the so-called ‘Santa Claus rally’, in some sectors returns were limited. This was a year where we learned a new term in investing, the so called ‘Magnificent Seven’, referring to US technology giants including Apple, Microsoft, Nvidia, Google and others whose market capitalization by the end of the year was 17% of the global stock market.
Part of the disappointment felt in 2023 was in relation to two major investment themes: healthcare and infrastructure. However, the argument for investing in these sectors has not gone away, arguably quite the opposite.
Investing in healthcare
While big tech’s dominance is not over, healthcare is poised to lead the economy in the next 10-20 years. We believe the sector will offer attractive investment opportunities for years to come, alongside consumer health and financial services catering to an aging population.
Healthcare investments have long played a pivotal role in modern investment portfolios and this should continue. This belief is supported by the following long-term demographic drivers:
- An ageing population in developed markets putting increasing pressure on health systems and driving innovation in more efficient and effective treatments
- Rising affluence in emerging markets is widening access to healthcare but also increasing demand, as that affluence is unfortunately also leading to an increase in previously ’western’ afflictions such as obesity, heart disease and diabetes
- The spread of innovation in pharmaceutical and biotechnology companies, such as the much-hyped launch of anti-obesity treatments and in new therapeutic areas that are even looking into arresting the ageing process
These drivers will boost demand for drugs, orthopaedic devices, healthcare services and other revenue generators for years to come.
Investing in infrastructure
Our belief in infrastructure investment is based on four main drivers: ageing infrastructure, green energy, electric vehicles and geopolitical stress.
1. Ageing infrastructure
Vast quantities of existing western infrastructure are crumbling due to decades of under-investment.
Famously, the US Army Corps of Engineers estimates that 42% of bridges in the United States are over 50 years old and over 46,000 are structurally deficient. Over the years several have collapsed, often with tragic consequences. There is a pressing need to rebuild roads and bridges, on which, surprisingly, both US political parties agree.
2. Green energy
The transition to a green energy system requires massive investment in new forms of power generation, such as wind, solar and hydro. There will also need to be a vast investment in the power grid to make it fit for these new forms of energy supply, many of which are intermittent and therefore more complicated to integrate.
In 2022, the US passed the CHIPS (‘Creating Helpful Incentives to Produce Semiconductors’) and Science Act. This injected hundreds of billions of dollars in subsidies and research grants into a range of areas, including accelerating the adoption of zero-emissions technologies.
Other countries, including in Europe, are instead extending their deadlines for achieving net-zero carbon emissions. However, we don’t believe this extension outweighs the significant opportunities offered by this likely multi-decade investment in infrastructure.
3. Electric vehicles
A transition to electric vehicles will create huge pressures on both the generation and distribution of energy. According to UK e-mobility service provider Zapmap, at the end of 2023 there were around 53,900 public charging points in the UK (and another 680,000 or so domestic ones). A previous 2021 study by the UK Society of Motor Manufacturers and Traders, a trade body, estimated that the UK will need around 2.3 million public charge points by 2030.
That means adding new points at a rate of 880 per day until the end of 2030. This is approximately 30 times the current rate of deployment and will create enormous stress on our electricity network, demanding a huge investment over the coming years.
4. Geopolitical stress
Heightened geopolitical stress is driving a boom in so-called ‘re-shoring‘. This is when critical industrial capacity is relocated from places like China, where security of supply may not be guaranteed, to countries closer to home, such as Germany.
What factors have affected the performance of healthcare and infrastructure?
Based on this evidence, it is obvious that there is still an extremely favourable long-term environment for both healthcare and infrastructure. So why have they underperformed?
Firstly, we must acknowledge the amazing run we’ve seen over the last 15 months from the ‘magnificent seven’ technology titans in the US. Today these seven companies account for well over 17% of the global equity market. On average, during 2023, these giants also rose in value by well over 100%, meaning that pretty much every other stock looked pedestrian at best and poor at worst compared with them. Healthcare and infrastructure have been no exception to this unflattering comparison.
However, the driver that has hit healthcare and infrastructure hardest has been the rise in interest rates. Traditionally, both these themes are seen as defensive areas of the equity market and are occasionally described as ‘bond sensitive’. As bond yields rose (and prices fell) from the end of 2021 through to the last quarter of 2023, their connection to these sectors acted as a major handicap to performance, even though in healthcare the emergence of anti-obesity drugs helped to mitigate this headwind.
Taking advantage of cheaper sector valuations
This leaves us in an interesting position. We believe the longer-term drivers that lie behind the attractive fundamentals of healthcare and infrastructure haven’t deteriorated. However, these sectors have suffered from weak performance in 2023 and this probably means they’re cheaper than they were before, making them extremely attractive now.
In conclusion, our view is that inflation will continue to subside (at least at the beginning of 2024), central banks will be in rate-cutting mode from the second quarter of this year, and bonds are solid value. This is a positive environment for infrastructure and healthcare, as their performance has mirrored bonds (fig 1) and we won’t be the least bit surprised if these sectors benefit from these mitigating factors.
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