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Paul and Brett's Alpha

October 2022

Things they do look awful cold

Investor interactions afford us the opportunity to gain some insight into the psychology and thought processes of our investors at any given time. Moreover, our willingness to engage in broader discussions of the stock market and the wider economy (as demonstrated in these very pages) often leads to conversations that cover topics beyond the investment remit of the trust. We enjoy markets and the business of analysis, so are more than happy to engage in these discussions.

What is fascinating about this dimension of our job is how expectations evolve with market sentiment. When the good times are rolling along, our opinion is but one of many and people seem happy enough to take away whatever they want from an interaction. As long as we remain confident in the longer-term outlook for the healthcare component, all is well it seems. If we express concerns or dissenting views that run contrary to received wisdom then people are more than happy to agree to disagree.

The current environment is a challenge for us all. The travails of daily life amidst inflationary pressures and Damoclean geopolitical overhangs are keenly felt. COVID may not pose the existential risk to life that many people felt in the spring of 2020, but its long shadow still casts a pall over many aspects of daily life, which still feels rather far from the norms of 2019. Very few investors have seen a positive return from their portfolios this year and many have also seen the income yield decline and of course inflation is eating away at the purchasing power of the income that remains.

This challenging environment seems to result in less willingness to simply ‘agree to disagree’ and we have been acutely aware of an unspoken desire (desperation?) to hear “good news”. As much as we are still very bullish on the longer-term outlook for the healthcare industry more widely, we are much less positive on the overall environment here in the UK and that is always a more challenging discussion point. We are not of the mindset to sugar-coat our views.

Paradoxically, it is the same demographic drivers that will support demand for healthcare services and the need for continued improvements in productivity within the healthcare industry that augur so unfavourably for the country as a whole and overall living standards. In the shorter-term, we feel the timepoint where this begins to unfold (as opposed to trying to kick the can yet further down the road) is fast approaching.

People try to put us down

Such has been the technological progress of the 21st century, it is almost axiomatic that each generation expects their children to enjoy a greater standard of living than their own. Lifespans have increased. Many medical ailments that previously ravaged the population are but a distant memory, especially infectious diseases.

Labour saving devices remove the drudgery from many tasks; one can spend their evenings arguing over the correct way to load the dishwasher, as opposed to “doing the dishes” for instance. 100 years ago, the idea of traversing the globe was an exciting adventure for the uber-rich of the gilded age. Today, globetrotting is an irritating hustle on budget airlines that occupies the gap years of middle-class students.

The first transatlantic telephone call took place only in 1927. Today, the latest iPhone has satellite communication backup, so you can send an SOS message from darkest Peru. In 1914, Goddard patented the design of the first solid fuel rocket engine. In 2014, the European Space Agency landed a probe called Rosetta on the Comet Churyumov–Gerasimenko as it hurtled through space at 34,000mph whilst it was 550m kilometres from Earth. In 100 years, we went from imagining putting an object into space to manoeuvring objects further away in space than one can imagine.

As the vaccine response to SARS-CoV-2 reminds us, history has shown time and again that betting against the collective wisdom of humanity is foolhardy. Even our imagination seems not to be a limit to what we can achieve over time.

Why then are we so worried about the future of our sceptred isle and fearful that the continued rise in living standards is, at best, going to pause and possibly going to reverse for a significant period of time?The simple answer is demography. We are getting old and that is an expensive business.

That ability to improve living standards relies on four pillars. The first is one of opportunity – there needs to be the chance to work in order to improve one’s lot in life. This is dependent on two other variables –education: the ability to acquire skills that add value and provide you with those employment opportunities and the third is health: you need to be well enough to be able to work and, inter alia, to enjoy the fruits of your labours.

The fourth pillar is more complex but relates to the cost of living. All of the above is for nought if, at the end of a day’s work, you do not have the means to acquire the things that you need and then the things that you want. Work must pay.

One way or the other, you are going to pay for the costs of the educational and healthcare services that are needed. This can be direct (private schools, private healthcare) and indirect (taxation) but all costs that must be met. Disposable income is what is left after food, shelter (including energy) and taxes (plus school fees and insurance premia for those fortunate to be able to bridge the public services gap) are paid.

Although UK exceptionalism and dreams of remaining a global soft and hard power linger on in political minds as echoes of our long-gone Empire, one has to accept that we now live in a global village. Whilst we will always need plumbers and painters to maintain the infrastructure of our lives, there is no obvious reason why the multinationals based here (e.g. GlaxoSmithKline or Unilever) need to hire a new marketing executive at their London HQ. People can work remotely from almost anywhere and even complex research teams nowadays are cross-border rather than all in the same laboratory. Many places have better weather too!

Production of the iconic Mini (the brand is owned by BMW, but the cars are often festooned with Union Jack motifs) is moving to China but we doubt anyone abroad thinking of buying a Mini will care where it was made. The only losers in this are the people currently working on the Mini production line and in its UK supply chain. We may well have a tight labour market today, but that is neither a guarantee this will continue, nor a positive for a prospective employer considering where to expand its operations to serve the global marketplace.

How then does the Government live up to Gordon Brown’s 2007 cry of “British Jobs for British workers” (as opposed to an Albania-like brain drain as the young depart for pastures new)? The country must provide its citizens with a good education and also the infrastructure that makes the UK an ideal base to set up labs and factories and working spaces. All of this requires investment.

The challenges that Britain faces are not unique amongst our OECD peers; Japan has wrestled with these issues for the longest; our own travails are mirrored by the United States who are not so far behind us and even China faces existential demographic challenges on a thirty-year view.

However, a paucity of natural resources and chronic under-investment in infrastructure arguably leave us less well equipped to cope with them than many of those peers; we have been under-investing for decades amidst the illusion that a combination of cheap money and low taxes will somehow keep the train on the tracks (or hide the crumbling of the edifice from view).

Investment is expensive and we have a corporate taxation system that does not encourage it. This is exacerbated by a governmental approach to regional infrastructure that almost prohibits local authorities from looking to raise revenues to maintain, never mind improve the attractiveness of certain parts of the country. Business rates cannot be cut materially in order to encourage regeneration for instance.

In addition to decentralisation, the answer to all of these problems is to spend more money: lots of it, everywhere. However, as we outlined in the first section of the factsheet, we already borrow too much of what we spend on public services that are deteriorating rapidly on both an absolute basis (roads, rail, healthcare etc.) and relative to international peers. The latter is very worrisome as it makes other countries look appear a more attractive place to build a factory or a lab or whatever.

If we cannot borrow much more, what do we do? There are only three options: cut spending, redistribute spending or increase taxes. The problem with any of these is that they will worsen quality of life in the short-term. Citizens will either be left with even worse public services or they will leave workers with less of their own “disposable” income to use as they want. There are no easy choices here.

I hope I die before I get old

Readers may be surprised to learn that the dependency ratio (a widely used measure of comparing the number of people aged 18-65 and thus of working age, with those over 65 and thus unlikely to be working) has not really changed in the UK over recent decades for a myriad of reasons. However, this is the calm before the storm. The dependency ratio is forecast to increase dramatically in the future. According to the UK Office of National Statistics, by 2050, one in four people in the UK will be over 65 and the vast majority of these will hope to be economically inactive.

This will have a significant (and positive, for BBH at least) impact on demand for health and social care related services. But many of those who are using these services are unlikely to be paying for them directly; they will be financed out of general taxation and the costs will thus be socialised to the working age population. However, that population will be much smaller and thus the burden of taxation will be spread more thinly.

In conclusion then, the future offers the certainty of higher taxation and not necessarily better public services. Already, the wealthier citizens of the UK are increasingly turning to private services to work around the gaps in public sector provision. Although the economic data does not capture it as such, this is a form of stealth taxation; who really wants to spend their retirement savings on services they imagined they had already paid for? Those that cannot “go private” are often falling out of the labour market through ill health (as the NHS backlog grows ever longer) or to care for a loved one who cannot get the social care that they need from the state. This is another vicious circle in the making.

Without those improvements in infrastructure, education and public services eibng realised, our diminished workforce and higher tax burden leads to a lower growth economy (cf. Japan). This, in turn, is not good for UK investors.

What is the solution to these problems? A bit of long-term thinking wouldn’t go amiss. Taxes are going to have to rise and, if we are going to take the pain of that, then let’s make sure it is done well. For instance, spending £100+ billion to cut the journey time from London to Manchester by 20 minutes whilst spending close to zero on helping people get around the North of England once they have arrived seems like a textbook example of how not to do an infrastructure project.

We do not envy Mr Sunak and would not want his in-tray on our desk. Post Truss though, he has the opportunity to start an honest political debate about all of this; a debate that is long overdue.

For the UK investor, the choices seem stark but a little more simple. Find something to buy that is geared into the global economy, decoupled from sterling as a currency and invests into an area where long-term growth is highly visible and not correlated to the economic cycle. If you have to buy a product listed on the UK market, then perhaps there is an investment trust that fits the bill…

We always appreciate the opportunity to interact with our investors directly and you can submit questions regarding the Trust at any time via:

shareholder_questions@bellevuehealthcaretrust.com

As ever, we will endeavour to respond in a timely fashion and we thank you for your continued support during these volatile months.

Paul Major and Brett Darke