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Emerging markets (EM) health care stocks struggled in 2022. In fact, the MSCI Emerging Market Health Care Index, a proxy for the asset class, was down 23% for the year, driven by a weak macro environment, global geopolitical instability, regulatory uncertainty, and ongoing COVID-19 disruptions.
Despite market volatility, we have high conviction in the long-term investment case for the EM health care market. These stocks stand to benefit from structural trends and improving innovation, and we believe now is the time for investors to consider engaging in the space.
In our view, good recovery signals are emerging, especially in China, which represents the biggest opportunity in the EM health care universe. We believe the China health care market has the potential to generate compelling returns amid faster-than-expected recovery now that the country’s COVID-containment policies have eased, and the regulatory environment has become more stable and predictable. Furthermore, with improving fundamentals and compelling innovation, we believe companies will be able to grow amid geopolitical volatility, which can create attractive entry points for investment opportunity.
After a roughly 50% pullback from the 2021 high, the MSCI China Health Care Index is now trading below its five-year average level. We believe that robust COVID recovery and a more predictable policy environment have created the opportunity for a re-rating.
Reduced COVID restrictions usher in recovery
One signal of a COVID rebound is recovering hospital traffic. Since the Chinese government lifted its COVID-containment restrictions in late 2022, hospitals are returning to business as usual after a two-year slump. Hospital traffic is an important metric of demand for health care. Greater hospital traffic leads to greater demand for medical drugs, devices, and related products, which signals the potential for better growth across the industry.
Supportive government policy encourages innovation
A supportive policy backdrop in China has significant ripple effects across the industry, encouraging investment in research and development, which leads to innovative pipelines. This is an important foundation as companies with innovative pipelines have a greater chance of addressing unmet clinical needs, a key driver of long-term returns in the space.
An important development is the stabilization of the government’s volume-based procurement (VBP) initiative, which has weighed on the biopharmaceutical and medical device industries for the past five years. VBP measures aimed to lower the price of medications and medical devices for consumers, hampering revenue and profitability for the impacted drug and device manufacturers. Now, the government appears comfortable with the price adjustments VBP has put in place and is easing up on its policies, seeking greater balance between cost control and innovation. More room for innovation speaks to future opportunity in health care in China.
We also see greater support for traditional Chinese medicine (TCM), which has a long history in the country and is a priority of the 14th five-year plan. The government recently expanded reimbursement coverage of TCM drugs and industry quality standards have improved — two convergent measures that provide better access and support innovation in this space.
Now that China is entering a more predictable, improving policy environment, we expect that earnings growth and visibility — especially of leading innovators — could be higher going forward.
Fundamentals can weather geopolitical volatility
We’re sanguine on the prospects of biotech and medical device companies that can develop best-in-class or first-in-class products. These types of companies have strong long-term growth potential because their products or services could be substituted in local markets in China and possibly enter markets in other regions. Product marketability in local markets is an especially important consideration here because the market demand is huge, with a large patient base, and global brands still dominate in most of the therapeutical areas. While China has experienced some geopolitical instability in the recent past, if its local markets can perform well, this may offset some international pressures from an investment perspective.
Economic reopening in China could also reaccelerate growth in other emerging health care markets. We anticipate that medical tourism in other parts of Asia could experience an uptick now that strict lockdowns in China have ended. Hospitals in Southeast Asia, for example, could experience growth from an influx of patients from China.
We also see compelling opportunities in India, where the health care services industry could experience strong growth, especially among affordable, local businesses. The prevalence of chronic diseases in India suggests a long-term case for Indian health care as leading hospitals work to meet demand. As the nation increases its supply of doctors, expands its health insurance industry, and improves its industry integration through digitization, the health care industry stands to benefit.
Ultimately, we’re optimistic about the investment potential of EM health care companies, thanks in no small part to easing lockdown restrictions in China. In our view, there is a compelling long-term case for the overall EM health care sector, and, especially this year, prudent investors may wish to focus on companies with strong China market exposure, reasonable valuations, and robust governance.
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