- Positioning changes implemented during the latest selloff proved beneficial as equities staged a powerful first-quarter rebound.
- ClearBridge is engaging companies in the drug value chain to better control opioid distribution and develop therapeutic alternatives to opioids.
- We are closely monitoring potential regulatory and legislative developments in the technology and health care sectors as well as signs that we are entering the later stages of the economic cycle.
Growth stocks resumed their upward climb in the first quarter, rebounding from the late 2018 selloff to deliver the best start to a year in two decades. The S&P 500 Index advanced 13.65%, it’s best first-quarter showing since 1998, the Russell 1000 Index added 14.00% while the Russell Midcap Index rose 16.54%. The benchmark Russell 1000 Growth Index rallied 16.10%, outperforming its value counterpart by 417 basis points.
Equities are rallying again against a decidedly mixed economic backdrop. The Federal Reserve paused its rate tightening program during the quarter, satisfied that inflation is under control and that the current moderate pace of GDP growth can be maintained. Continued solid employment numbers and strengthening wage growth suggest the consumer is in good shape. But weaker manufacturing data and a yield curve inversion in March, coupled with the lack of resolution to trade negotiations between the U.S. and China, suggest business activity could slow going forward. Our portfolio companies are expressing growing caution with a general pause in activity.
The Large Cap Growth ESG Strategy takes a diversified, long-term approach that seeks to promote a stable return stream across varying market and economic conditions and across growth companies targeting both consumer and enterprise spending. Our focus on a company’s growth prospects over a three to five-year time horizon provides opportunities to take advantage of short-term price dislocations to add to existing positions or establish new ones. Shares of Nvidia, for instance, which we added in the fourth quarter following the chip maker’s disappointing earnings results, rose more than 30% during the first quarter.
Nvidia falls into our select growth bucket of companies generating high revenue and earnings growth from innovative business models that seek to disrupt existing markets or create new ones. Grubhub is our newest position in the select bucket and increases our exposure to consumer spending trends that we believe have staying power. Grubhub is the largest online and mobile food ordering and delivery company in the U.S. The company, which operates under multiple brands and platforms including Seamless and LevelUp, is a leader in a nascent market in online restaurant ordering for pickup and delivery that is growing steadily. Grubhub is currently in an investment cycle to gain presence in new markets, but margins should improve as spending tapers off in 2020 and order frequency increases. Expanding to smaller markets and increased competition pose risks but we believe the company is well positioned as long as customer acquisition costs hold steady.
In addition to repositioning our consumer discretionary allocation, we were active during the quarter in trimming our health care exposure. Here we closed positions in biotechnology holdings Celgene and Regeneron Pharmaceuticals. Global drug maker Bristol-Myers Squibb announced in January its intentions to acquire Celgene at a more than 50% premium. Celgene had underperformed prior to the deal news as investors were concerned that its own recent acquisitions signaled a weaker pipeline, slowing revenue growth and earlier generic risk for its leading therapy, Revlimid.
Regeneron specializes in treatments for serious medical conditions including macular degeneration and atopic dermatitis. The stock has performed well and has been trading at the high end of our valuation range. The company’s Eylea eye treatment has significant exposure to Medicare Part B, which appears to be a governmental bullseye relating to prescribing incentives and rebates. Regeneron remains a leading, innovative biotech company with great financial partners and many molecules in early trials for PD-1 T-cell and gene therapy, but it also serves crowded markets.
We continue to evaluate our options for another biotechnology holding, Biogen, which sold off sharply after a surprise announcement that it was ending clinical trials for Alzheimer’s treatment aducanumab. We have always recognized the risks in the company’s pipeline and continue to see value in its Spinraza franchise, however the cancellation of Biogen’s Alzheimer’s program could negatively impact the stock’s long-term risk/reward profile. Offsetting weakness in Biogen, Alexion Pharmaceuticals was a solid performer thanks to the strong launch of its Ultomiris treatment for a rare blood disorder.
Health care was a positive contributor for the quarter, boosted by Thermo Fisher Scientific, a company in the stable growth bucket of leading franchises with predictable earnings and cash flows. Thermo Fisher is a diversified global provider of products, services and research to the biotechnology, government, diagnostics and industrial markets. The company’s management team has successfully driven growth through accretive acquisitions.
As the political season gears up, we are expecting policy comments within both information technology (IT) and health care that are more rhetoric than reality. These sectors represent significant exposures in the portfolio and we are keeping a close eye on factors in both. Recently announced government plans to reform rebates in Medicare Part D and drug payments in Medicare Part B as well as Congressional efforts to advance “Medicare for All” legislation could impact health plans, pharmacy benefit managers and distributors. In addition, we are monitoring health care inflation and the potential for pricing controls on pharmaceutical and biotech treatments. Within technology, several of our portfolio companies with significant Internet businesses could be subject to increased regulation over data usage and privacy.
"Rather than try to time shifts in the economy, our focus remains on portfolio companies and sourcing new growth ideas."
The current U.S. economic expansion is showing signs of age. Rather than try to time shifts in the economy, our focus remains on portfolio companies and sourcing new growth ideas through bottom-up fundamental research. A balanced approach to portfolio construction, characterized by the three buckets of growth companies detailed above, helps promote consistent long-term results. This perspective allows us to be more active buyers during periods of price dislocation.
For the first quarter, the ClearBridge Large Cap Growth ESG Strategy underperformed its Russell 1000 Growth Index benchmark. On an absolute basis, the Strategy had gains across all 10 sectors in which it was invested (out of 11 sectors total). The primary contributors to performance were the IT and communication services sectors.
On a relative basis, overall stock selection and sector allocation detracted from performance. Specifically, stock selection in the IT, industrials, communication services and financials sectors were the primary detractor from relative returns. The Strategy's cash position also had a negative impact. On the positive side, stock selection in the health care and real estate sectors drove relative performance.
On an individual stock basis, leading individual contributors to absolute returns in the first quarter included positions in Facebook, Amazon.com, Apple, Celgene and Alphabet. Biogen, Grubhub, CVS Health, Nutanix and Qualcomm were the biggest detractors.
During the first quarter, the Strategy initiated new positions in Grubhub and Advance Auto Parts in the consumer discretionary sector and closed positions in Celgene and Regeneron Pharmaceuticals in the health care sector.
ESG Highlights: A Multifaceted Approach to the Opioid Crisis
Opioid abuse has become such a serious issue that it is included in the UN Sustainable Development Goal #3, Good Health & Well Being, which includes a target to strengthen the prevention and treatment of substance abuse, including narcotic drug abuse. Appropriately used, opioids are an important and effective treatment for chronic and acute pain. They carry, however, the serious risks of misuse, addiction, overdoses and death. There is no profile of a typical user or potential misuser: according to The Hartford, one in three people will be prescribed opioids in their life. Athletes and office workers, teenagers and adults, family members and neighbors — anyone could be involved or affected by opioid misuse.
Since the prescription of opioids began to increase significantly in the 1990s, the number of opioid overdose deaths has likewise risen (Exhibit 1). So has the economic burden: one study estimated the total economic burden of fatal overdoses, abuse and dependence of prescription opioids to be $78.5 billion in 2013 alone.1 The opioid epidemic causes more than 130 overdose deaths per day in the U.S.2 Opioids were responsible for almost two thirds of all drug overdoses in the U.S. in 2015; roughly half of these involved prescription opioids. Yet even while prescribing rates have fallen from peaks in 2010–2012, the amount of opioids prescribed per person is still high — three times higher than in 1999.3
Exhibit 1: Rise in Opioid Overdose Deaths
As an active investor in public equities, ClearBridge pursues a multifaceted approach to support efforts to reduce opioid addiction. ClearBridge is engaging companies in the drug value chain to better control opioid distribution and develop therapeutic alternatives to opioids. We are also supporting portfolio holdings in the insurance industry that identify those most at risk of opioid addiction and prevent dangerous cases before they begin. Helping efforts to reduce opioid addiction also aligns with our efforts to support UN Sustainable Development Goal #3, Good Health & Well Being.
Finding Solutions Across the Drug Value Chain
Patient access to opioids and lack of education on usage risks are primary contributors to the opioid epidemic. As a shareholder of companies across the drug value chain, ClearBridge encourages and supports these companies with the ability and the responsibility to act. Our roles as an active manager include engaging with distributors on their efforts to prevent potentially irresponsible dispensation of opioid drugs and investing in pharmaceutical companies developing therapeutic solutions.
ClearBridge portfolio holdings in the distribution segment of the value chain are working to stop inappropriate diversion of prescribed opioids. The key is that they not be overprescribed, either in cases where one patient’s prescription contains too much opioids at once or for too long a time, or where too many people are getting prescriptions, some unnecessarily. Distributors are making changes to how they operate to help fight the crisis. CVS Health, for example, has worked with other distributors to build a network of shared records, so one user cannot simply go to a different pharmacy to get a prescription filled. The company has also developed programs for the safe disposal of unused opioids, preventing discarded opioids from finding a market.
In addition, we have a history of engaging health care companies on anesthesiology and the adoption of non-opiate approaches to pain management. We have engaged CVS, Amerisource Bergen and UnitedHealth on how their pain clinic managers ensure appropriate opioid use.
Patients are also prescribed opioids for dental health care; dental health care professionals write 12% of all opioid prescriptions, almost half of which are for adolescents. A recent Stanford study found that routine painkillers prescribed to teens after wisdom teeth removal could contribute to opioid addiction in young adults.4
"Long-acting local anesthetics can work just as effectively as systemic versions and might even prevent initial opioid use."
UnitedHealth has launched oral health programs and policies to reduce opioid access in a number of ways, such as limiting the level of the prescription through the UnitedHealth oral pharmacy policy, as well as mailing information about the risks and proper use of opioid prescriptions to patients with dependents from the ages of 16 to 22 years. In addition, UnitedHealth will track the dental professionals who are among the top 10% opioid prescribers in their network and notify them of their status. After being contacted, these professionals have reduced prescriptions by 17%. The program has been updated to flag the top 20% oral health prescribers.
While opioids are the most prevalent and cost-effective form of pain management for many use cases, we are also investing in companies developing alternative therapeutic solutions. Portfolio companies Pacira Pharmaceuticals, Alkermes and Heron Therapeutics are developing opioid substitutes which would allow use of non-systemic pain relief in surgeries – long-acting local anesthetics that work just as effectively as systemic versions might even prevent initial opioid use.
Pacira Pharmaceuticals manufactures and markets Exparel, a treatment that can serve as an alternative to alleviate post-surgical pain, a primary introduction point for opioid use. The current standard of care to manage post-surgical pain is oral or intravenous opioids and there are few alternatives that offer pain relief as effectively. Exparel is a long-acting formulation of a well-known local anesthetic injected directly into the surgical site during a procedure to block pain locally, rather than systemically. By being given Exparel during surgery, patients can either avoid the use of post surgical opioids or significantly reduce their dose and duration of use.
We have also discussed efforts to address the opioid crisis with pharmaceutical maker Alkermes. The company sells Vivitrol, a long-acting injectable drug that reduces the effect and craving for opioids. The drug is used as part of rehabilitation protocols, along with detoxification and therapy/counseling, and is clinically proven to decrease abuse relapse rates. Vivitrol is used instead of opioid replacement therapies like methadone. In addition to traditional drug marketing, Alkermes has engaged at all levels of government and the justice system to broaden the use of Vivitrol to combat the growing opioid addiction problem in the U.S, including in federal prisons.
Heron Therapeutics is a pharmaceutical maker with two commercial anti-nausea treatments for patients going through chemotherapy. We are excited about the prospects for a next-generation non-opioid painkiller in Heron’s pipeline (HTX-011) for post-operative pain that is expected to receive FDA approval around the middle of 2019. Heron is benefiting from fast-track approval procedures that have been established by the FDA to encourage innovation and that we believe can bring non-opioid treatments to market in a timelier manner.
Insuring a Better Approach to Use of Painkillers
As the opioid epidemic has begun to have a more and more tangible impact on employers, property & casualty insurance companies, such as ClearBridge holdings The Hartford and Travelers Insurance, have been proactively working to detect addiction and tailor rehabilitation. Due to in-house triage personnel, insurers have a unique perspective on the crisis in that they often have the first look at treatment and prescription trends that might involve opioid use. Both The Hartford and Travelers are fighting the opioid crisis by holistically working with doctors on diagnosis and treatment for employees in filing workers’ compensation claims.
Both The Hartford and Travelers are pursuing innovative programs to combat opioid addiction by using predictive analytics to identify drug-seeking behavior. The Hartford uses an analytics model that incorporates nonmedical psychosocial factors, such as subtle verbal cues, to identify claimants at higher risk of addiction. Using this model, The Hartford has seen opioid use on its claims drop by 25% from January 2015 to July 2016; the average morphine equivalent dose per claim decreased by 9% over that time frame as well.
Travelers has developed an Early Severity Predictor® to identify when an injured employee develops chronic pain, so it can work with employees and their doctors to eliminate or reduce the need for painkillers.
These programs help monitor and reduce the risks of addiction, which not only saves livelihoods and lives, but also benefits employers in terms of reduced lost work time, lost productivity and lower insurance costs. Since 2015, The Hartford has been able to help workers’ compensation claimants reduce opioid use by 43%.
ClearBridge supports and encourages these practices and makes them part of our long-standing conversations with Travelers and The Hartford. Our ownership of these companies is an example of cases where smart ESG practices serve the interest of both shareholders and society.