Global Equity Observer
March 23, 2023
Diagnostics: The Workhorse of Improving Health Outcomes
Global Equity Observer
March 23, 2023
Diagnostics: The Workhorse of Improving Health Outcomes
March 23, 2023
For health care companies, the holy grail of compounding at high returns is underpinned by pricing power, barriers to entry and non-discretionary end market demand. Whilst non-discretionary demand can provide a ballast to compounding power for investors, it has stark implications for other stakeholders: for the patient, it may mean “no other choice”. “Non-discretionary” often means overburdened health systems — because hospitals and providers cannot cut back on treatment when budgets tighten, costs balloon or patient numbers increase.
This forces the question: what constitutes a valuable health care intervention? We think that wider use of diagnostic testing and early screening carries the benefit of improved patient outcomes, as well as the potential to optimise health care expenditure. Diagnostics inform 70% of clinical decisions, yet comprise only 2% to 5% of health care funding.1
Reducing the Cost of Sickness
It was refreshing to see the chairman of the UK-based biopharmaceutical business we own talk about the need to "reduce the cost of sickness" at the 2023 World Economic Forum in Davos earlier this year.2 During his address, Mr. Johansson was clear that achievement of this goal lies in screening and early diagnosis, rather than in drug development alone. This is an interesting comment coming from the chairman of one of the world's largest drug developers; but perhaps a warranted one given the extraordinary spending by pharmaceutical companies on research and development (R&D). Annual oncology R&D spend is estimated to be around US$50 billion globally,3 but improvement of survival rates has been stubbornly slow. Interventions being developed by large pharmaceutical companies generally target advanced disease, with drugs extending median survival by months not years. In the 30 years between 1992 and 2022, survival rates for American women with late-stage breast cancer doubled, but only to 29%.4
The potential for diagnostics and early-stage screening to improve survival rates looks enormous. In the case of cancer, the earlier the disease is treated, the more likely that pharmaceutical interventions will extend survival. Take the example of breast cancer: the five-year survival rate for women in the U.S. with breast cancer that has not spread beyond the breast is 99%.5 6 However, if the cancer has spread, the survival rate falls dramatically, to just 29%. The difference between the two survival rates is down to when the disease is caught and diagnosed.
Together, diagnostics and predictive analytics can enable clinicians to make better treatment decisions and even keep patients out of hospital. Predictive algorithms have been used in intensive care units to identify patients more likely to need surgical interventions.7 Hospitals have reported reduction in mortality as a result.8 On top of this, 39% of surveyed health care executives said that using predictive analytics and diagnostics had reduced costs.
The cost reduction to the health care system from wider use of diagnostics and screening can be significant. For example, it is estimated that the cost of treating a specific type of lung cancer is $231,000 per year in the U.S. 9 Compare this to an equivalent screening cost of $19,000 per year, or less than 10% of the cost of treatment.10 Additionally, if physicians can correctly identify the type of disease through diagnostic testing, health care systems do not waste costly drugs on patients whose cancer would not have responded to that drug in the first place. As such, specific diagnostic testing may also enable physicians to provide more cost-effective treatment.
Striking the Right Balance
Of course, there has to be a balance struck between improving current levels of screening and not overburdening health systems with the cost of screening entire populations too frequently. Screening whole populations for lung cancer at $19,000 per year is not exactly an insignificant financial burden. There is also the issue of false positives for populations who are over-screened or are sent for screening when the disease would be too small to detect anyway. Possibly the best example of early-stage screening is also the oldest: the Pap smear (testing for cervical cancer) only entered widespread use 40 years after its invention, in the 1960s. Since then, incidence and mortality rates for cervical cancer have come down by more than 50%.11 Despite this success, it took 40 years to fully implement a screening programme. This shows that balancing cost, precision and behavioural adaptations is not easy.
There is also the question of those diseases for which screening is available but therapeutic intervention is currently limited. A pertinent case of this is screening for the genetic risk of developing Alzheimer’s disease. Australian actor Chris Hemsworth recently revealed that he is at increased risk of developing Alzheimer’s after he underwent genetic testing. He was found to be a carrier of a gene that increases his risk of developing the disease eight to 12-fold versus someone who does not carry a copy of the gene at all.12 Although this information can be helpful in terms of managing risk factors, not everyone may have the ability to employ interventions to manage the risk (such as exercise, diet or experimental therapies). The test can tell a patient if they are at heightened genetic risk of developing Alzheimer’s but does not offer a treatment. Whilst this certainly holds advantages, it can raise more questions than answers on an ethical front. As such, there is clearly a balancing act between diagnosis/screening and therapeutic interventions.
Diagnostics companies are exposed to massively important trends in the improvement of health outcomes and the need for providers to manage costs. They often enjoy high levels of recurring revenues and barriers to entry: once a diagnostic machine is installed, the manufacturer will sell consumables that allow the machine to run different diagnostic tests. This often ensures a captive customer for high margin and predictable revenue streams. We think that these features make diagnostics businesses high quality companies to invest in.
We own several diagnostics companies in our global portfolios. Our life sciences holdings derive between one-quarter and one-third of their revenues from diagnostic testing. They hold large market shares in a concentrated and growing end market. Innovation from these companies has enabled improvement in the quality, breadth and efficiency of diagnostic testing. For example, the American multinational medical devices and health care company we own is developing a blood test that can test for concussion and predict outcomes from brain injuries within 15 minutes.13
Another customer for diagnostic testing is the pharmaceutical and biotech industry. In many cases, diagnostics providers are also important to the drug development process, through their manufacture of "companion diagnostics". Diagnostic tests will often be developed alongside a drug to better identify patients who should have a positive response to it. For example, the American analytical instruments provider we own is partnering with the biopharmaceutical business we hold to develop diagnostic tests for some of its oncology drugs. For the analytical instruments provider, this carries the benefit of resilient end market demand and regulatory protection, without the risks associated with traditional pharmaceutical company revenues: trial failures, patent expiries and pricing pressures.
Having seen the potential for diagnostic testing and early-stage screening to reduce the cost of sickness, it feels fair to argue that this should be viewed as a non-discretionary, if not under-used, cog in the health care ecosystem. We think that demand for diagnostics is well underpinned given that the use case for wider and early-stage screening is strong.
For the investor, these companies can offer high returns on operating capital employed, underpinned by barriers to entry and recurring revenues. They are exposed to massively important trends where they can enable better outcomes and save on costs. We rarely see these companies dominate the headlines for major advances in curative therapies, but beneath the surface they have strong potential to meaningfully improve mortality rates from life-limiting diseases.
ISIN: LU0360482987 | Class Z
ISIN: LU1842711845 | Class A
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market value of securities owned by the portfolio will decline. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this strategy. Please be aware that this strategy may be subject to certain additional risks. Changes in the worldwide economy, consumer spending, competition, demographics and consumer preferences, government regulation and economic conditions may adversely affect global franchise companies and may negatively impact the strategy to a greater extent than if the strategy’s assets were invested in a wider variety of companies. In general, equity securities’ values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. Stocks of small- and mid-capitalisation companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility. ESG strategies that incorporate impact investing and/or Environmental, Social and Governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance.
Return On Operating Capital Employed (ROOCE) is a ratio indicating the efficiency and profitability of a company’s trade working capital. Calculated as: earnings before interest and taxes/property, plant and equipment plus trade working capital (ex-financials and excluding goodwill).
There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.
A separately managed account may not be appropriate for all investors. Separate accounts managed according to the particular Strategy may include securities that may not necessarily track the performance of a particular index. A minimum asset level is required.
For important information about the investment managers, please refer to Form ADV Part 2.
The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.
Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or the investment team. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific strategy or product the Firm offers. Future results may differ significantly depending on factors such as changes in securities or financial markets or general economic conditions.
This material has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and the Firm has not sought to independently verify information taken from public and third-party sources.
This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.
Charts and graphs provided herein are for illustrative purposes only. Past performance is no guarantee of future results.
The representative account has employed the investment strategy in a similar manner to that employed in the team’s separately managed accounts (“SMAs”) and other investment vehicles, i.e., they were generally operated in a consistent manner. However, portfolio management decisions made for such representative account may differ (i.e., with respect to liquidity or diversification) from the decisions the portfolio management team would make for SMAs and other investment vehicles. In addition, the holdings and portfolio activity in the representative account may not be representative of some SMAs managed under this strategy due to differing investment guidelines or client restrictions.
The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.
This material is not a product of Morgan Stanley’s Research Department and should not be regarded as a research material or a recommendation.
The Firm has not authorised financial intermediaries to use and to distribute this material, unless such use and distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are required to satisfy themselves that the information in this material is appropriate for any person to whom they provide this material in view of that person’s circumstances and purpose. The Firm shall not be liable for, and accepts no liability for, the use or misuse of this material by any such financial intermediary.
This material may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this material in another language, the English version shall prevail.
The whole or any part of this material may not be directly or indirectly reproduced, copied, modified, used to create a derivative work, performed, displayed, published, posted, licensed, framed, distributed or transmitted or any of its contents disclosed to third parties without the Firm’s express written consent. This material may not be linked to unless such hyperlink is for personal and non-commercial use. All information contained herein is proprietary and is protected under copyright and other applicable law.
Morgan Stanley Investment Management is the asset management division of Morgan Stanley.
This material is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.
MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC, and Atlanta Capital Management LLC.
This material has been issued by any one or more of the following entities:
This material is for Professional Clients/Accredited Investors only.
In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited ("FMIL"). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at The Observatory, 7-11 Sir John Rogerson’s Quay, Dublin 2, D02 VC42, Ireland.
Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.
In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch) Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland.
Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International) Limited (“EVMI”) 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority.
Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain: MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain. Germany: MSIM FMIL Frankfurt Branch, Große Gallusstraße 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Denmark: MSIM FMIL (Copenhagen Branch), Gorrissen Federspiel, Axel Towers, Axeltorv2, 1609 Copenhagen V, Denmark.
Dubai: MSIM Ltd (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158).
EVMI utilises a third-party organisation in the Middle East, Wise Capital (Middle East) Limited ("Wise Capital"), to promote the investment capabilities of Eaton Vance to institutional investors. For these services, Wise Capital is paid a fee based upon the assets that Eaton Vance provides investment advice to following these introductions.
NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A DEPOSIT
Latin America (Brazil, Chile Colombia, Mexico, Peru, and Uruguay)
This material is for use with an institutional investor or a qualified investor only. All information contained herein is confidential and is for the exclusive use and review of the intended addressee, and may not be passed on to any third party. This material is provided for informational purposes only and does not constitute a public offering, solicitation or recommendation to buy or sell for any product, service, security and/or strategy. A decision to invest should only be made after reading the strategy documentation and conducting in-depth and independent due diligence.
Hong Kong: This material is disseminated by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this material have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this material shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This material is disseminated by Morgan Stanley Investment Management Company and should not be considered to be the subject of an invitation for subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of Singapore ("SFA"); (ii) to a "relevant person" (which includes an accredited investor) pursuant to section 305 of the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore. Australia: This material is provided by Morgan Stanley Investment Management (Australia) Pty Ltd ABN 22122040037, AFSL No. 314182 and its affiliates and does not constitute an offer of interests. Morgan Stanley Investment Management (Australia) Pty Limited arranges for MSIM affiliates to provide financial services to Australian wholesale clients. Interests will only be offered in circumstances under which no disclosure is required under the Corporations Act 2001 (Cth) (the "Corporations Act"). Any offer of interests will not purport to be an offer of interests in circumstances under which disclosure is required under the Corporations Act and will only be made to persons who qualify as a "wholesale client" (as defined in the Corporations Act). This material will not be lodged with the Australian Securities and Investments Commission.