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James Carthew: Polar Capital and quest for income from healthcare

James Carthew: Polar Capital and quest for income from healthcare

I was surprised earlier this month to see an announcement from Polar Capital Global Healthcare (PCGH) headlined ‘announcement re future of the company’.

Surprised because PCGH is rapidly approaching the end of its fixed seven-year life and proposals about the future of the company are supposed to be put to shareholders at the AGM next year. It does not seem that long ago that it was being launched!

Shareholders who want an exit will be given the chance to cash in their investment, but the board has also said they hope to offer a rollover into a new healthcare trust managed by Polar Capital.

I wrote about PCGH back in the summer of 2013. I thought it might be worth having a look at how it has done since then. The AIC’s biotech and healthcare sector is dominated by the £1 billion market cap Worldwide Healthcare Trust (WWH), which is managed by the same team as the second largest fund, Biotech Growth Trust (BIOG).

With a market value of £214 million, International Biotechnology (IBT) is a little bit smaller than PCGH. This has been PCGH’s peer group for most of its life but in December we saw the successful launch of BB Healthcare Trust (BBH).

It is not a homogeneous group of funds. The main difference between them has been the size of their allocation to biotech companies as compared to pharmaceutical and other healthcare related companies. The returns from biotech have been stellar for most of PCGH’s life – as an illustration, BIOG’s share price rose more than five-fold between June 2010 when PCGH was launched and July 2015.

Over the past 18 months though that part of the healthcare market has been volatile. PCGH has some exposure to biotech (9.4% of the portfolio at the end of 2016) but that compares to a 17.7% weighting within the MSCI AC World Healthcare index (PCGH’s benchmark). By contrast, WWH, which has the same benchmark, was overweight biotech relative to the index at the end of December.

PCGH stands out from the rest as its investment objective contains a commitment to produce an income return as well as growth of net asset value (NAV). As I explained in the 2013 article, PCGH’s initial target yield of 3% on the issue price was achieved, but NAV growth was much faster than income growth and, for most of its life, PCGH has been trading on a yield closer to 2%.

In part, it generates that yield by having a much larger amount invested in large, mature pharmaceutical companies than its peers. PCGH had 61.3% invested in the pharmaceutical sector at the end of 2016 while its weighting in the benchmark was 47.4%. WWH says it is underweight pharmaceuticals relative to the index.

Over the period from launch through to the end of December 2016, PCGH returned 150.2% while its benchmark returned 171.2%. That underperformance mainly arose in the earlier part of PCGH’s life however, when the biotech sector was strongest.

In 2016 PCGH matched the benchmark. Over the past five years, PCGH’s returns have come in about 8.6% per annum less than WWH’s and it is the worst performing fund in the peer group.

As PCGH shareholders contemplate the announcement and the board and manager consider the way forward, I expect the fund’s performance record relative to the benchmark and the peer group to play a major part in their thinking. The advent of additional competition in the form of BB Healthcare will also concentrate their minds.

The big question I think is whether the focus on generating income from the portfolio has compromised total returns. It is a question that many funds have grappled with over the years. An increasing number of funds investing in areas that don’t throw off a lot of income are paying dividends out of capital. Could this be the way forward for PCGH mark two?

James Carthew is a director of Marten & Co

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