2 Health-Care Funds Find Innovative Opportunities

Star bond picker Jeffrey Gundlach pooh-poohed inflation fears in his keynote address at this week’s Morningstar Investment Conference. But elsewhere in Chicago’s McCormick Place convention center, managers of health-care funds say that in the sector they track, increasing costs are as predictable as the sun rising in the east. And, they add, health-care reform will only make matters worse.

Andy Acker, manager of Janus Global Life Sciences T (symbol JAGLX), says that the new legislation would be better deemed health-care expansion rather than reform. While the bill is expected to introduce some 30 million new customers to the industry, it does little to control costs. “It’s going to be a very tricky dance for companies in this space,” says Kris Jenner, manager of T. Rowe Price Health Sciences (PRHSX).

Both managers look primarily for companies that promise innovation. Insurers are sure to reimburse only products and services that fulfill “true unmet medical needs,” says Acker. For example, three million Americans and many more foreigners are chronically infected with Hepatitis C. The existing treatment is painful. It requires weekly injections that can produce yearlong side effects of flu-like symptoms yet offers just a 40% chance of being cured. So both managers like Vertex Pharmaceuticals (VRTX), a Cambridge, Mass., company that is working on a new Hep C treatment that it hopes will cut the treatment time in half and increase the chance of being cured to 70%.

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Acker and Jenner are also intrigued by a new treatment for systemic lupus erythematosus, or SLE, which is a form of lupus that affects internal organs. Human Genome Sciences (HGSI), in conjunction with GlaxoSmithKline (GSK), is on the cusp of introducing a drug named Benlysta and “really changing the practice of medicine,” says Jenner. He prefers Human Genome Sciences to Glaxo because the former, with a market value of about $4.6 billion, is much smaller than Glaxo, which carries a market capitalization of $90 billion. As such, the new drug will have a much greater impact on Human Genome’s profitability than on Glaxo’s.

But Acker also sees Glaxo as an indirect play on emerging markets. The British company derives about one-fourth of its sales in those fast-growing nations. Ackers expects Glaxo to generate double-digit annual sales growth in developing markets over the next few years.

Acker invests directly in emerging-markets companies, too. For example, he likes OdontoPrev, Brazil’s leading dental insurer, with three times the market share of its next largest competitor. Only 15% of Brazilians have dental insurance, compared with 70% of Americans, so he sees enormous growth potential for OdontoPrev. “In many of these countries, we see an emerging middle class that will be increasingly larger consumers of health care,” he says.

Jenner agrees that emerging markets will be a big driver of growth in the health sector. But he warns investors to be aware that investing in those nations entails great risks, including differences in oversight, securities laws and corporate governance. Investing in emerging markets “is fundamentally an away game,” he says, “probably best left to those firms that have the resources to be there in person.”

Jenner took over the reins of the Price fund in 2000, so the fund’s fine long-term record is meaningful. Over the past ten years through June 24, it returned 5.7% annualized, beating the typical health-sector fund by an average of nearly four percentage points per year. Over that period, Standard & Poor’s 500-stock index lost an annualized 1.1%.

The Janus fund hasn’t done nearly as well over the long term. It returned 0.6% annualized over the past decade. Acker, though, only became manager in May 2007. Over the past three years, the fund lost 1.7% annualized, compared with a 1.9% annualized loss for the average health-sector fund and an annualized loss of 8.6% for the S&P 500. Over the three-year period, the Price fund gained 0.7% annualized.

The Janus fund charges 1.03% in annual expenses, while the Price fund extracts 0.87% a year. Both require a $2,500 minimum investment.