“The health care industry's powerful growth profile coupled with its magnitude and complexity create myriad investment opportunities.” From the web site of OrbiMed, subadviser to the fund
Over the past decade, the Eaton Vance Worldwide Health Sciences Fund (Trades, Portfolio) has earned an average annual return of 9.5%, strong enough to give it a 10th-place rating among all the gurus followed by GuruFocus (ranked by 10-year average annual returns). And since inception, in 1985, it has earned an even more impressive 12.8% on average each year.
It’s one of two health funds in the top 10 over 10 years on the GuruFocus Scoreboard: the other is the Vanguard Health Care Fund (Trades, Portfolio).
What they have in common, of course, is the sector. Yet there are undoubtedly hundreds of other funds that focus on the same sector or industry without posting stellar performance results. In this article, we examine the investing philosophy behind the fund in a search to find factors the rest of us might use to improve our results.
This article is one in a semiseries examining the top 10 stock-picking gurus (sometimes individuals, sometimes teams). The other nine are: David Tepper, Prem Watsa, Bill Ackman, Seth Klarman, Chuck Akre, Vanguard Health Care Fund, Yacktman Focused Fund, Jerome Dodson and Frank Sands.
Who manages the fund?
The Worldwide Health Sciences Fund is managed by Eaton Vance Management, part of a company that has been in the business since 1924, managing mutual funds since 1931. Jason Kritzer, CFA, and Samantha Pandolfi, CFA, are the portfolio managers.
They are supported by OrbiMed Advisors, which is listed as the investment subadviser. It describes itself as managing some $13 billion in public and private company investments with a Life Sciences focus.
What is the fund?
The fund says its objective is to “seek long-term capital growth by investing in a worldwide and diversified portfolio of health sciences companies.”
It offers units through five classes:
- Class A: Front-load charges (reductions apply on initial investments of more than $50,000).
- Class B: Back-load charges (reductions may apply).
- Class C: Back-load charges (reductions may apply).
- Class I: Sold by financial intermediaries; initial investments of more than $250,000; no sales charges.
- Class R: Sold to employer-sponsored retirement plans and Individual Retirement Account rollover clients of financial intermediaries (who charge their own fees).
In some cases, back-load charges vary and are called contingent deferred sales charges (CDSC).
Most individual investors would need to pay hefty fees upon buying or selling units in the fund, and relatively high management expenses each year, making profitable ownership a challenge. Compare this fund with the Vanguard Health Care Fund that charges no front- or back-load and has an annual expense ratio of 0.36% (but the initial minimum investment is higher, at $3,000 versus $1,000 for Eaton Vance’s Worldwide Health Sciences).
Investing philosophy
The company explains its investment philosophy in the Prospectus:
- It invests at least 80% of its assets in securities, mainly common stocks.
- Target companies’ main line of business involves the “discovery, development, production or distribution of products (or services) related to scientific advances in health care, including biotechnology, pharmaceuticals, diagnostics, managed health care and medical equipment and supplies.”
- At least 50% of the target companies’ sales, earnings or assets must come from the application of scientific advances related to health care.
- It "normally" invests in companies that have locations in or are economically tied to at least three different countries.
- The fund may also invest limited amounts in royalty bonds, ETFs, short positions and derivatives (the latter as a hedge on stock prices and currencies or as a substitute for stocks/currencies. It also aims to bring in extra income by writing cover calls or puts (options).
The portfolio managers don’t necessarily look for deep value; rather they look for stocks that are reasonably priced and will increase in value over the longer term. They say their selection process involves multiple factors, including:
- Potential to increase market share by bigger companies.
- Research and development projects by smaller companies.
In addition, they consider eliminating one name from the portfolio when they add a new one.
There’s a distinct growth flavoring to this investment philosophy of the Worldwide Health Sciences Fund. And the word "sciences" seems appropriate, given that a linchpin of screening appears to be "scientific advances." Presumably, such advances lead to moats and premium pricing, which, in turn, lead to better margins and earnings.
Current holdings
The following chart, from the fund’s Annual Report (fiscal year end Aug. 31, 2016), shows that the Pharma subsector has the largest place:
As of Nov. 30, 2016 (end of the fund’s first quarter of fiscal 2017), GuruFocus has the following companies as the fund’s top 10:
- Roche Holding AG (ROG, Financial).
- Allergan PLC (AGN, Financial).
- Eli Lilly and Co. (LLY, Financial).
- Celgene Corp. (CELG, Financial).
- Johnson & Johnson (JNJ, Financial).
- Biogen Inc. (BIIB, Financial).
- Medtronic PLC (MDT, Financial).
- Pfizer Inc. (PFE, Financial).
- AbbVie Inc. (ABBV, Financial).
- Zoetis Inc. (ZTS, Financial).
This is a concentrated, or high-conviction, portfolio with just 38 stocks and quarter-over-quarter turnover of 10%.
Seven of the fund’s 38 names are international, as displayed in this GuruFocus table:
This portfolio features some long-time pillars of the health sector along with a couple of relatively newer names. In a fund with a limited number of holdings, like this one, each stock must contribute consistently if the portfolio is to make money.
Fund performance
Obviously not all names were contributing in 2016 as the fund dropped nearly 15% in the calendar year; the fund’s year-end was on Aug. 31, 2016 and on the fiscal year, the Annual Report says it experienced “a total return of -7.31% for Class A shares at net asset value (NAV), underperforming the -1.04% return of the fund’s primary benchmark, the MSCI World Health Care Index.”
The following GuruFocus table shows the fund’s performance over the past 10 calendar years and compares it with performance of the Standard & Poor's 500:
In its Annual Report, the fund attributes much of its 2016 fiscal-year problems to the political environment: “While stocks rose broadly across many global markets, health care stocks struggled during the 12-month period amid fears of the potential of rising drug prices. Fueled by statements made during the U.S. presidential campaign, these fears impacted health care stocks worldwide, particularly in the biotechnology and pharmaceuticals industries.”
No doubt the fund managers spent much time and money honing their portfolios, only to see them suffer because of extraneous events –Â black swan events some might say.
Conclusion
The losses of fiscal and calendar 2016 underline the importance of a long-term perspective. Yet there is a bigger story in the Worldwide Health Sciences Fund, and that is the ability of the fund’s managers to consistently earn above average returns over so many years.
The health care industry of 2017 is far different than the health care industry of 1985 (when some computers were still controlled by punch cards) yet this fund has continued to deliver strong returns to its investors.
At the same time, individual investors with less than $50,000 to put into one specialized area should probably invest elsewhere. With a front-load of 5.75% and an annual expense ratio of 1.4%, it’s bound to be an uphill climb for many years after starting. The Vanguard Health Care Fund, which does not charge any sales fees, has a lower management expense ratio and delivered comparable results would be a better choice for most investors. A different, yet similar, argument could be made against the back-load classes of Eaton Vance.
Finally, the fund’s mandate of selecting companies that derive at least half of their sales, earnings or assets from the application of scientific advances to health care is an idea worth further exploration. Absent black swan events, it’s about as good a driver of growth and potential capital gains as any.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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