(PUB) Investing 2016

has doubled this fund’s return since inception. Heck, even the Income Model Portfolio , which takes on less risk, has outpaced STAR LifeStrategy Growth. I guess my bottom line is that you shouldn’t bother investing here. Admiral Tax-Managed Capital Appreciation Sell. Good in concept, this fund is now showing its age.

Tax-Managed Capital Appreciation aims to track the Russell 1000 index while minimizing taxes. Typically, Vanguard’s indexing group buys a selection of the Russell index’s stocks that pay little or no dividends while still trying to mimic the overall index in terms of industry allocation, market capitalization and the like. The fund has historically held about 650 stocks, though there have been two

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investors can do better following one of my Model Portfolios and making strategic changes to their holdings. My Conservative Growth Model Portfolio allocates a little more than 80% of assets to stocks and has beaten the pants off of this option since incep- tion through August, up 655.1% versus 425.9%. The Growth Model Portfolio

INTERVIEW > JEAN M. HYNES Innovation Ahead

able to use data, you have this explosion in biology which is going to bring many more advancements to the drug world than we’ve seen in any other period. The point about winners and losers is that the pie can’t grow beyond a certain level, so how does that pie get split? The pie will have to be split in a way that benefits the innovators. And it will benefit companies that really help to reduce health care costs or deliver health care in a much more efficient way. This is a long-term evolution which started a couple of years ago. That’s not a widely held view yet. There will be surprises, for example, in biosimilars and how fast they will be adopted by payers and health insurers around the world. Why would you think that adoption of biosimilars will be a surprise? If you look at the history of oral drugs when they first started losing their patents, it took five years for the volume to go away. Prozac was the first patent expiration in the industry for a long time, and its erosion to generics surprised people. Management teams and the market were surprised by how fast the erosion curve was for oral solid pills. When you hear people write about biosimilars, they expect a 20%–30% price cut and maybe a 20% erosion—a slow erosion. But with new drugs that treat Alzheimer’s or the immuno-oncology drugs, there is going to be pressure to move more quickly. Payers will become much more creative than people are thinking. If you look at the stocks of companies that have a significant amount of potential biosimilar-erosion, it’s not yet reflected in the stocks at all. It has been a tough year for health care stocks, particularly rela- tive to the broader market. Your 12-month returns through August were the sixth worst relative to the S&P 500 since the fund’s inception in 1984, and the worst since the year ending December 1999. Why should I continue to invest in a health care sector fund? First of all, it would be interesting to know how many of the periods [of underperformance] were around election years. With health care being such a large part of the market and of the economy, it is always volatile during election years. And 2015–2016 is no exception—there is this overhang of what will happen with drug pricing. If you look at how many drugs and companies have had super-large price increases, it’s a very small absolute number. When it comes to the dynamics of health care pricing, what’s reported in newspapers and the reality of the system are very different. There are four different markets—you have the commercial payers, Medicare, Medicaid and

EVERY SECTOR HAS ITS TIME in the sun. The past year has been one of the worst relative 12-month periods for Health Care in its history, making now an excellent time to check in with Jean Hynes, 47, of Wellington Management, who’s been a part of the Health Care team for more than two decades, and solo manager of the fund since 2012. Is it time to give up on health care stocks? I don’t think so, but read on to see what Hynes thinks. Jean, in your most recent letter to shareholders, you write that you expect to see greater divergence between winners and losers in the health care arena, which of course plays right into my belief that active management will win out. Can you expand on that? I’ve been at Wellington for 25 years, and I’ve been investing in health care for almost that whole time, so I’ve seen different cycles. The 1990s and the 2000s were about an expansion of health care through more insurance and more coverage of drugs, and everyone did well. Of course, there were parts of the market that had better drugs or innovation or drugs gained market share, but the pie was growing for all players. Going forward, absolutely the pie will grow. There is almost no way it doesn’t grow, given demographics, but we are at a tipping point—there are going to be a lot more people over the age of 75—that’s going to put enormous pressure on volumes over a 10-year period. This means govern- ment and payers can’t allow health care to grow unchecked. People over the age of 75 use three or four times the health care services that they do when they are younger, and people are living longer—some believe there will be a million people over 100 years old within 10 or 20 years. So that is going to put a tremendous amount of pressure on systems, and health care as a percentage of GDP probably can’t grow much more in many countries. Health care systems around the world need to change how they do things and need to change incentives. It’s starting in the U.S. with digital health care; electronic medical records allow payers and the government to change how health care is delivered. And it will happen more slowly, but it will definitely happen, as the rest of the world digitizes health care. That’s the very big picture. As choices have to be made, how does the health care system make those choices? We are in the golden age of understanding biology. At the same time the population is hitting a tipping point and governments and payers are

12 • Fund Family Shareholder Association

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