As the US presidential election approaches, the M&G high yield team have been examining sectors and companies that could be affected most by alternative party mixes in the next US administration. The healthcare sector, one of the largest components of the US high yield index (approximately 9%), has naturally been a particular area of focus. It is a heavily regulated area, whose fortunes are closely tied to shifts in government policy and legislation, making it potentially highly susceptible to the election results.
Depending on the Presidential outcome, changes could be imminent for the Affordable Care Act (ACA) -- or “Obamacare”, as it is more commonly known. President Trump and the Republicans have tried unsuccessfully to overturn the Act, but it is now being challenged as unconstitutional. A case is scheduled to be heard by the US Supreme Court seven days after the election. The replacement of liberal Justice Ruth Bader Ginsburg following her passing in September with Justice Amy Coney Barrett (a staunch conservative) earlier this week increases the probability the legislation will be overturned.
Why is this important to fixed income investors and the high yield segment in particular?
The ACA is important for a number of different US healthcare subsectors, particularly hospital companies. Some earn between 15 and 20% of their profits from provisions stipulated by the ACA, so any threat to the legislation could have a significant impact on their financial performance, particularly for those that are highly levered. As active investors, we need to be aware of the possible scenarios to assess the likelihood the ACA is repealed and to ensure we are being adequately compensated for this risk in portfolios we manage. The election and the court case are likely to cause some volatility in the sector, so extra vigilance may be necessary regarding portfolio positioning in the weeks and months ahead as the outcome of the case is unlikely to be known until early 2021.
Several scenarios could play out. A ‘blue sweep’ where Biden wins, the Democrats retain the House of Representatives (as widely expected) and win the Senate (less likely) – will make the court ruling largely irrelevant, as a new bill can be drafted alleviating the concerns of the Supreme Court, even if it was to overturn the legislation. However, if the Republicans hold on to the Senate, a legislative ‘fix’ seems less likely. Furthermore, if the court rules against the ACA, and the Republicans retain the Senate, the bill could be potentially overturned and then get side-lined for many years. Potential risks such as these will probably challenge high yield investors before and after the election.
There are also direct policy proposals that make the election result important for many healthcare companies. On the face of it, a Biden and Democrat victory would appear a good thing for the healthcare sector, especially in the event of a ‘blue sweep’. Democrats would be expected to spend more on healthcare. However, the overall outcome in the healthcare sector is a little more nuanced.
The two primary mechanisms that Biden is in favour of are:
1. Instigating a “Public Option” – essentially a federal government health insurance plan to compete with the private sector. While most Americans get their healthcare cover through their employer, a high proportion of the population remain uninsured. The public option gives both insured and uninsured an opportunity to purchase health cover directly from the federal government. However, this creates increased competition for healthcare companies, as insurers face direct competition from the government. It also potentially puts pressure on hospitals, if reimbursement rates get squeezed by a hard-bargaining government.
2. Biden is also in favour of changing Medicare (providing for the elderly). He wants to lower the eligibility age for Medicare to 60 from 65, enabling younger people to buy into the system – a cheaper option than commercial insurance – thus expanding healthcare coverage across the population. This may also create margin pressure for healthcare companies. From a high yield investor perspective, this potentially spells trouble for healthcare providers that are highly levered.
Healthcare sector volatility typically increases around elections because many of the companies are sensitive to legislative and regulatory changes. Political commentators and the investment industry are trying to assess the likelihood of various possible outcomes, in order to judge whether the risks are being priced appropriately in the market. Any changes thrown up by the election could present a springboard for further company engagement, an increasingly important part of our investment decision process.
Many people assume that more money spent on healthcare must be a good thing for the industry. However, that argument is more nuanced. As high yield bond investors, we dive deeper to get a clearer picture of how it could ultimately affect profit margins, and then eventually financing costs. This analysis needs to be carried out on a sector-by-sector and company-by-company basis, in order to see if risk is being accurately priced in the market.
The value and income from a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.
The views expressed in this document should not be taken as a recommendation, advice or forecast.
M&G TALKS Webcast: US Election Result
Please join us on 5 November at 15:00 GMT when Jonathan Willcocks, Global Head of Distribution, discusses the US election result and the potential impact on markets with fund managers Randeep Somel and Tristan Hanson.