The healthcare sector is one of the most important areas to invest for the greater good of humanity, but it has long posed challenges for ESG investors.
In the US, there are more than 350 sustainable mutual funds and ETFs with some exposure to healthcare stocks, with the average allocation to the industry being 12.9%, according to data from Morningstar Direct.
That figure, slightly lower than the 13.7% of healthcare stocks in the S&P 500, has changed little over the past few years.
US sustainable funds with healthcare holdings represented $28.7bn as of the end of March, or 8.4% of the total $342.2bn in sustainable funds, Morningstar Direct data indicate. Assets in both areas have more than doubled over the past three years, but the proportion of sustainable funds that invest in healthcare has remained about the same.
The highly regulated industry carries high litigation and reputational risks. And in some cases, access to medicine – an extremely important topic from and ESG standpoint – can have issues related to distribution, which can be impeded by supply chain or political issues. On top of that, emissions reporting has been a low priority for much of the sector.
Those factors and others can result in relatively poor ESG scores from ratings firms, leaving socially responsible investors with much to consider.
“It’s positive impact business – they provide products that help people. But at the same time there are all those operational and business risks,” said Hortense Bioy, global director of sustainability research, manager research, at Morningstar and ESG Clarity Committee member. “That makes some ESG investors wary of the sector.”
Some of those issues have become more apparent during the pandemic, Bioy noted.
Pharmaceutical companies “had a lot of pressure from government to come up with these vaccines, and in some markets, the marketing of these vaccines is heavily dependent on the governments,” Bioy said. “For example, they’ve been allowed to market the vaccine in some countries – but based on prices they had to agree on. They can’t do whatever they want. In that sense, it can be a very scrutinised.”
In some cases, the industry has cited bribery issues or corruption that interrupted distribution, she said.
“Some companies have been accused of not supplying enough [vaccines], but actually the pharmaceutical companies are not saying it’s a distribution problem, not a supply problem,” she said.
More broadly, the pricing of drugs and other products can raise questions about affordability for the people who need them the most, leading to significant reputational risks.
That, along with lobbying practices, anticompetitive behaviour, animal testing and questionable clinical trials make a tough pill to swallow for socially responsible investors, Bioy said.
“It’s far from being a very ethical business.”
Morningstar makes a distinction between normal pharmaceutical companies and those that make “impact” products, such as for cancer and rare diseases, she said.
Some impact investors want to include companies that focus on very specific issues, in their portfolios, she said.
Access to healthcare is one of the biggest issues facing the industry, but so too is off-label marketing, in which companies promote products to be used in ways not approved by regulators such as the Food and Drug Administration, said Julia Giguere-Morello, head of ESG and climate research at MSCI.
“It used to be more of an issue several years ago. We’ve seen less off-label marketing issues arise, but it continues be one of the key risks specifically for the pharmaceutical companies,” Giguere-Morello said.
One lesson the industry has recently learned is that supply chains can be disrupted, making redundancy all but necessary.
“We are seeing some shifts, post-Covid, where there is more dual sourcing,” Giguere-Morello said. “[Companies] realise they simply can’t rely on one market.”
A subset of the access-to-healthcare issue MSCI is focused on is a mismatch between what the public needs and the research and development resources dedicated to that. A big problem starts in another industry – agriculture, Giguere-Morello said.
Antibiotic resistance, which has been fuelled by industrial farms’ widespread use of antibiotics in animals, represents a massive risk to both health and finances, she said.
“We’re asking ourselves what’s the next emerging risk beyond Covid,” she said.
“The first thing we think about is antibiotic resistance … It’s very clear that the annual death projections by WHO and others are 10m a year [by 2050] – that’s more than cancer, diabetes and road accidents combined. The financial costs are projected to be than the 2008 financial crisis.”
It’s a problem that smaller, private companies have been working on, often in partnership with other groups, she said.
Part of that is genomic technology, which is being explored to address antibiotic resistance.
But fully confronting the issue will take action from regulators to limit the use of antibiotics that is common at factory farms.
“It’s a systemic risk for the healthcare system as a whole, but it represents an opportunity for these smaller companies,” Giguere-Morello said.
Compared with other industries, healthcare can see lower marks from ESG ratings firms – but the reasons for poor ratings are sometimes questionable, said George Dai, chief investment officer at Weatherbie Capital, in a recent interview with ESG Clarity US.
“One is the product recalls, which is viewed negatively by the [ratings] methodology … and two is intellectual property disputes, which is also viewed negatively. They consider that risk,” Dai said.
“Number three is a high price. Of course, we would love to have a cancer-curing drug that is priced at zero.”
Recalls do not necessarily look good, but they can show that a company is prioritise the wellbeing of patients, he said.
“That’s actually a lot of work [and] financial damages to the companies, but why do they do that?” he said.
“It’s because they actually act out of their corporate responsibility. They have their conscience, and they are willing to sacrifice financial gains to do that for the benefit of the patient’s health.”
As an example, he cites Johnson & Johnson’s famous recall of Tylenol in 1982, after some packages in Chicago were tampered with and pills were poisoned with cyanide.
Seven people died, and the business recalled 31 million bottles of the pain reliever before relaunching products with tamper-resistant packaging, according to The New York Times.
“In today’s ESG rating agency framework, that would be like viewed very negatively,” Dai said.
“But it was a case study. It served as a poster child of responsible corporate behaviour. And so that’s something I cannot reconcile.”
While patent litigation does not show the same kind of social responsibility, it is a norm in an industry that invests heavily in research and development, he said.
“Without patents, what happens? Nobody’s going to invest, because why should I put in $1bn to invent the next drug, when you can just copy it the next day?” he said.
“IP disputes are just part of the normal life. They should not be penalised, and they should not be given negative scores, simply because [companies] are disputing with each other.”
Only about one out of five companies in MSCI’s healthcare sector coverage has any kind of emissions-reduction target, and those that do have done so voluntarily for Scope 1 and 2 emissions.
Most do not even consider Scope 3 emissions, the greenhouse gas equivalents that happen across their value chains – including areas such as transport, testing and materials, Giguere-Morello said.
“We don’t tend to think about healthcare on the climate and carbon front,” she said.
“Healthcare is wholly unprepared for the net-zero transition and this massive reallocation of capital.”
That will almost certainly have to change if and when regulators require standardised emissions and carbon-risk disclosure.
“There is a real opportunity there for the healthcare sector to increase its efforts toward decarbonisation,” Giguere-Morello said.