ANNOUNCER: TD Asset Management welcomes you to this week's podcast. As a reminder, this podcast cannot be distributed without the prior written consent of TD Asset Management.
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INGRID MACINTOSH: Hello, and welcome to the TDAM Talks podcast, a podcast where we dive deep into the world of investment markets. We'll share the latest trends, insightful analysis, and then cover some strategies that could help you navigate the complex landscape of investing. I'm Ingrid Macintosh, head of Global Sales Enablement Marketing and Digital Strategy here at TD Asset Management, and I am thrilled to be joined by some of the sharpest minds in the asset management industry and my colleagues.
Podcast today about the pleasure of welcoming back a true maverick on TM's investment research team. You may remember Tarik Aeta, currently leads our Insights into Global Healthcare. And aside from helping us make informed decisions in the health-care space, he really did become one of our most popular experts, providing us updates during the pandemic. He's here today so that we can chat about the trending topics of the role of healthcare and provide insights into some of the great opportunities in the sector. But that said, welcome Tarik.
TARIK AETA: Thanks for having me on, I appreciate it.
INGRID MACINTOSH: OK, so health care was the sector to own last year but mostly forgotten this year, and now it's showing real signs of revival again. Can you start by providing our listeners with some context of, really, what's driving the performance, and really, how it's represented in equity markets more generally?
TARIK AETA: Right, OK. Thank you. So maybe before we look at this here, maybe we'll take a step back and look at the big picture, and then we'll double-click on this year specifically. But firstly, when we do look at the 10,000 foot view and we zoom out even beyond the investment implications, our personal health is our greatest asset.
Good health gives us hope. It opens doors to pursue our passions and allows us to enjoy life to the fullest. And as such, health care has been codified as a human right with governments, individuals, and corporations spending ever greater amounts into health care. So when we take this back into the world of investing, health care as a result benefits from many attractive qualities, including strong growth, inelastic demand, and low sensitivity to the economic cycle. And this combination has generated strong returns for investors in the sector, with $1 invested in the S&P 500 health care index 30 years ago worth $35 today, ahead of the broader S&P 500.
And as a result, health care is now the second largest sector in the S&P 500 with a 14% rate, second only to technology. Maybe turning back to your original question in terms of what has weighed on the sector over the past year, you know, first and foremost has been weak earnings.
Earnings in the last quarter were down 14%, and that has been driven by the fact we've lapped some really strong COVID driven earnings, as demand for vaccines, therapeutics, vaccine manufacturing equipment, and testing have all declined. And also this year, we've seen investors leave some defensive sectors, including health care, staples, and utilities, and gone into technology, consumer discretionary, communication services, really driven by the large mega-cap tech names. But that rotation, we're probably likely in the later innings of.
INGRID MACINTOSH: Yeah, so I love what you said about it being a really inelastic sector because it's going to be before. I know people like both sectors. We talk both sectors as investing themes, but I think people love to talk a little bit about stories. And I'm hearing a lot about GLPs, and this is one of the biggest healthcare trends. Can you talk to us about what they are and why they're so popular?
TARIK AETA: Right, yeah. Yeah, you're absolutely correct. So there's been significant investor excitement around these new GLPs for diabetes and obesity. And the data out of Novo Nordisk's SELECT study that we got in August just continues to reinforce the potential. So maybe for listeners, we'll just recap, what are GLPs? So GLPs stands for Glucagon-Like Peptide receptor agonist. Yeah, yeah, it's a mouthful to pronounce. But at the core, the way these drug works is fairly simple. Essentially, they make you feel full. They make your stomach empty more slowly and ultimately will make one eat less.
So at first, these drugs were really designed for type II diabetes to lower one's blood sugar, but then they noticed people would take these drugs would lose weight on them. So what Novo Nordisk did is create a higher dose of Ozempic. They branded it as Wegovy and began selling it in the obesity market in 2021. And this drug is a big step change in the treatment of obesity, driving 17% weight loss, which is a big deal because if you just go three years ago, the best obesity drug would only deliver 6% weight loss. So we're basically running at literally triple the best drug just three years ago.
INGRID MACINTOSH: I think what's really interesting about it, too-- and I've done some my own research on this-- is it's kind of-- it's reversed the demonization of obesity and really said, you know, there is something chemical going on in your bodies, and you do need support. And I think that's been a real game changer in the global mindset around, which is why I think there's been a terrific take-up.
TARIK AETA: Yeah. So, yeah, yeah, it is very impressive. And what's also impressive is that we're now approaching the 23% weight loss you tend to get with bariatric surgery, where you open someone up, you cut their stomach, you staple it back down, and but now you can get that same impact with just a drug without all the risks and complications of surgery. And with 700 million individuals globally and 40% of American adults struggling with obesity, there's definitely a long runway for these drugs to grow. You may be wondering, though, like, what is the catch, and what are the barriers in driving growth? And in terms of the rollout, frankly, the biggest driver is just getting enough manufacturing capacity, with demand continuing to outstrip supply. And the other barrier in the medium to longer term is just getting employers and government willing to cover these drugs. And they're not cheap. They cost over $10,000 US per year.
And historically, that was slow to happen because weight loss drugs were considered not medically necessary. Exactly. Exactly. But like mental health 10, 20 years ago, social attitudes are changing. And I would expect weight loss drugs will be increasingly covered by employers and governments. And that process really started 10 years ago when the American Medical Association in 2013 officially recognized obesity as a disease. And fast forwarding to the end of last year, we now have 15 countries providing reimbursement for these drugs, and 50% of employees in the US get reimbursement for these drugs through their employer.
INGRID MACINTOSH: That obesity managed in the short-term actually leads to much lower costs on the health care system.
TARIK AETA: Right, exactly. So there are stats that show that the average person struggling with obesity costs the health care system an extra $4,000 US per year on top of all the other external costs as well from living with the disease. And I think part of what's going to help accelerate adoption going forward is clinical data that shows that weight loss drugs do more than just benefit the cosmetic weight loss. So, including areas like reducing the risk of diabetes, cardiovascular disease, sleep apnea, orthopedic damage.
And that's why Novo's select study back in August was so important is that it showed that Wegovy reduced the risk of cardiovascular death, heart attacks, and stroke by 20%. And this will further get more adoption of these drugs by health care practitioners and patients.
INGRID MACINTOSH: So growth, growth, and growth. I'm going to pull it back a little bit. And we're talking about something very specific, and it's something that's on everyone's minds, but we pull it back a little bit and talk more broadly about the sectors that are captured within health care. Can you talk a little bit about that?
TARIK AETA: Right. Yeah, so although there are thousands of publicly traded health care companies globally, at the end of the day, they all really fall under one of three simple buckets. And I call these the three Ds of health care. So these are, one, the companies are Discovering drugs; two, the companies are Developing widgets; and three, the companies are Delivering services. So the first bucket are the companies are discovering drugs, so these are your pharma and biotech companies. But for the mega-cap companies, it is a tough business as they're constantly running on this treadmill of patent expiries, with internal R&D often having a hard time to keep up.
So names like Novo Nordisk and Lilly are really more the exception, rather than the rule, in this case. So when we invest in this space, we're generally looking for companies that have a combination of [INAUDIBLE] expiries, a large drug development pipeline that can drive revenue growth, and a management team that has historically delivered on R&D and commercialization of new drugs.
The second bucket that we look at are the companies that are developing widgets. This includes medical device manufacturers that make everything from pacemakers, surgical robots, artificial heart valves, and the list goes on and on. And the benefit of this group is they benefit from the secular growth in the demand for health care, but with less R&D risk than pharma and biotech.
Yeah, and it's a little bit like the iPhone. The beauty of these medical device companies is that no one wants to have-- for instance, with the iPhone, a lot of patents with the original iPhone, the original iPhone was launched in 2007. Patents will expire in 2027. But in 2027, no one is going to want the original iPhone. They'll want to have the latest and greatest technology.
And that's the same thing with these medical device manufacturers. They're always iterating on their products. And physicians and the healthcare community keeps keep upgrading to the latest generation. And that's why even though some of the original patents might expire, it doesn't really impact the business economics because people always want to be on the latest generation of technology. And there's another great group of companies also here are the life science tool companies. And they make basically the picks and shovel required to discover and manufacturing drugs, so everything from multi-million dollar electron microscopes to basic lab supplies. And what makes them so attractive is that no matter which pharma or biotech company succeeds, they're basically the arms dealer supplying the entire pharma and biotech space.
INGRID MACINTOSH: So, all boats get lifted here?
TARIK AETA: Yeah, exactly.
INGRID MACINTOSH: Irrespective of outside selection, probably diversified. We talk about this a little bit deeper on the sort of continuous cycle of innovation, right? What are some of the newest technologies that are driving this progress in health care? What should we be thinking about?
TARIK AETA: Yeah, so there's a lot of innovations continuously happening across the health care sector, and we could probably spend an entire podcast about that. But maybe I'll highlight a couple things that I'm watching at the moment. So in terms of big themes to watch, what I'm watching include cancer drugs, Alzheimer's, robotic surgery, new pain drugs, gene therapies, liquid biopsies, and of course, diabetes and obesity.
Maybe double thinking on one of these themes, outside of diabetes and obesity space, would be the oncology or cancer drug space, which is arguably one of the more promising ones. And the reason for this is that there's still tremendous unmet need in society in search of better cures for cancer.
So for example, if we look at the US today, the number of cardiovascular deaths have declined by 20% over the last 50 years, even though the population in the US has grown by 60% during that period, which is testament to all the innovations we've seen in that in that space. But on the other hand, the number of cancer deaths have actually grown faster than the broader population growth, up 70% over the last 50 years.
But yeah, in this case for cancer, there's two promising technologies I'd watch out for. So first would be mRNA-based personalized cancer vaccines. This is being developed by Moderna in conjunction with Merck, which is a big player in oncology. And the way the technology works is that they sequence the DNA of the cancer. They find out what unique markers exist on that cancer cell. And then they create a personalized mRNA vaccine for each patient that will target their cancer.
And December, we got the first glimpse of that data from Moderna. It was a phase II trial in melanoma, a kind of skin cancer. And what it showed is that a report is that the patients that had the drug got a 44% reduction in the recurrence of cancer, which is more effective than what many people expected. And then, yeah, then just to close off, another development in oncology space is the emergence of antibody drug conjugates.
Basically, what makes those drugs unique is that they combine the precision of an antibody-based drug, like Merck's Keytruda, but also a cytotoxic agent, like chemotherapy attached to it. So the idea is that when the drug reaches the cancer site, it releases the chemotherapy warhead directly at the cancer site, which means you can deliver more chemotherapy directly at the cancer site, while limiting the toxic effects elsewhere in the body.
INGRID MACINTOSH: So if it doesn't kill you, the treatment will. That's what we used to say, right?
TARIK AETA: Yeah.
INGRID MACINTOSH: And I think-- what I [INAUDIBLE] similar to is this idea of living longer with cancer, so sort of health sustainment, like recognizing that the cure isn't the be-all, but the treatment that's part the growth area [INAUDIBLE].
TARIK AETA: Yeah, so I guess the one thing with cancer is that we're still looking for the silver bullet that can cure cancer. And we're still many years away, but a lot of the innovations we've seen in the cancer space are basically allowing us to live longer. So the idea is you have one generation of drug that can extend your life by year, and again, another generation of drug that can extend your life by another year. And you string along a lot of these drugs together, and you can extend your life by 1, 2, 3, 4 years. Some of them are obviously more effective than others, but definitely the most effective thing for cancer is early detection. And there's a whole set of other innovations that are trying to work in trying to identify cancer earlier. But there's definitely still a long runway for innovation to grow in the cancer space.
INGRID MACINTOSH: I think you have direct innovation. Health care innovation is the competitive space, especially with the pharmas, and obviously, everybody's racing to try and find those cures. We've talked about this in some other podcasts, specifically those that have AI, but can you maybe talk about the roles that artificial intelligence might be playing within the health care sector? Are we starting to see some emerge?
TARIK AETA: Yeah, so we've, obviously, seen a lot of chatter about ChatGPT and consumer use cases for AI. We haven't seen as much in terms of health care, but that said, under the hood, there are quite a few developments happening. So we can have AI used to diagnose and do treatment planning in cancer. You can use AI for predictive analytics to intervene earlier in a disease progression. You can use it to improve surgical robotic outcomes.
But personally, what I think the biggest opportunity is for AI in the healthcare space is to improve drug discovery. And this is because discovering a new drug is a difficult endeavor. It's very expensive, and it usually fails, so--
INGRID MACINTOSH: Drug companies are always incented to do--
TARIK AETA: Yeah, exactly. So, yeah, this makes drug discovery very difficult. And also, the cost of drug discovery has gone up quite a bit. These cost less than a billion dollars 20 years ago to discover a new drug, and that cost has gone up to 3 billion a year-- 3 billion per drug. So while AI-driven drug discovery has been talked about for 30 years, what is finally making it more realistic is the fact that we've had big advances in GPUs, and we can simulate how a hypothetical drug would interact in the human body by running trillions of calculations in the cloud.
And the second thing has been more accurate application layers that can model how potential drugs may interact in the human body. So all in, using AI in drug discovery can potentially save 2 to 3 years off the time needed to bring a new drug to market. It can reduce the number of drugs that would have to be stress test in the lab and increase the probability of success.
So all in, what does this mean for the pharma and biotech companies? It probably means they can probably save a couple $100 million on the cost of developing a new drug. At the same time, they can also potentially bring more drugs to market. And for society as a whole, we also benefit because there's the potential for more drugs that can cure previously unmet needs, ranging from cancer, Alzheimer's, and many other diseases. So the simplest term, it was AI. It is a huge productivity boost to the health-care sector.
TARIK AETA: Exactly. And I just think it will take-- and unlike consumer use cases for AI, I think this is a story that will play out over 5, 10 years, but definitely, it's a very real story.
INGRID MACINTOSH: You can see AI really play a role in crowdsourcing the identification of rare diseases, like those diseases that don't get well covered, but that's for another podcast. It's interesting, what you and I were chatting before this. We were really talking about health care as a growth sector. Like, let's talk a little bit about that. Let's really drive home that point for our listeners because I think we talked to vertical automation, we talked about the sustainability of the health-care sector. But truly, let's talk about it as a growth option [INAUDIBLE].
TARIK AETA: Yeah, yeah. So, yeah, definitely, I [INAUDIBLE] be very constructive on the healthcare sector when taking a multiyear view, and it's driven by two things, as you mentioned. It's a growth sector, and what drives the growth is two very, very simple things. So, first is a growing and aging global population. As we all get older, we all consume more health care services. And that's the first thing that everyone intuitively understands.
And the second driver of growth in health care, which is arguably more important, has been innovation, with the sector continuing to spend more on research and development each and every year. And that means that the pipeline for innovation will remain robust for many years to come. So all in, when you combine demographics plus innovation, which are the two drivers, health care spending in the US has grown at an 8% compound annual rate since the 1960s. That's only 2% faster than broader GDP growth, but as you know, through the power of compounding, that 2% extra over time adds up to quite a bit.
And that should continue for many years to come because demographics are written in stone. We know for the next 20 years, demographics will continue to be a tailwind for the sector, maybe a little bit less so. But beyond 2040 is a long time away. And innovation will remain strong. So overall, health care should continue to post stronger growth than the S&P 500 over the longer term.
INGRID MACINTOSH: So that's your long-term view, but we started this narrative with a conversation about why, now, we're acting particularly bullish. Can you talk a little bit about?
TARIK AETA: Right, yeah. So earlier in the year, I was a bit more cautious on the sector, but fast forward to today, I'm more constructive for two reasons. So first of all, the sector is now trading at a discount to the S&P 500 once again. So valuations are attractive here. And second, going into 2024, the narrative around healthcare will change this year. It's been we have all these COVID products are not selling anymore, whether it's vaccine testing, therapeutics.
But going into next year, not only we won't have the headwind from these products no longer selling, but you'll also benefit from the tailwind of a lot of these new innovations selling more and more, whether it's in diabetes, obesity, cancer. So overall, the narrative around healthcare will very much change going into 2024, and I think that will help improve sentiment around the sector.
INGRID MACINTOSH: Then, how do we think about healthcare and portfolio? So in your role leading research for the healthcare sector, you're advising our portfolio managers and making the recommendations on the outpatients?
TARIK AETA: Right, yeah, so when it comes to health care, generally, my view has been we should follow a core and satellite approach when it comes to investing in health care. The core is very much driven by companies like the health insurers or life science tools that benefit from the secular growth of the sector without having to take individual R&D risk and individual drug companies or individual medical devices. So that generally is my preference, to have those companies as the core of the portfolio. But then as a satellite, try to include companies that benefit from secular themes that have a lot of potential, whether that is obesity, diabetes, cancer, robotic surgery. Those companies, you have to be a bit more careful when you invest in them. They have different tail risks, different R&D risk, but if you buy them at the right valuations, with the right tailwinds behind them, they can perform very well over time. And that's generally the way I've tried to approach the sector.
INGRID MACINTOSH: Tarik, so much amazing information here. Thank you so much. We've covered a lot of ground. If I've sort of summed up for you, we've really given our listeners a deep dive into what drives the health care sector, what it actually looks like, what are some of the themes and why a growth sector. Your work and the work for research showed benefits all of our fundamental equity strategies here at TD Asset Management.
But I'd also say for our advisor DIY audience, I'd like to point out that there is an ETF for all of that as well. The growing population, coupled with this continued innovation, inexplicably leads to growth that many investors are looking for. The TD Global Health Care Leaders Index ETF, or TDOC, aims to capture this growth while providing a low cost to [INAUDIBLE] health portfolio with global exposure. So you can check out the links in the podcast summary for more information if you're interested. Tarik, thank you so much for joining us today
TARIK AETA: Thank you, Ingrid. I appreciate it.
INGRID MACINTOSH: And for our audience, remember, you can always get the latest expertise from TD Asset Management. Follow us on Twitter @TDAM Canada, and on LinkedIn at TD Asset Management. Thanks, everyone, and stay healthy.
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