The drugs don’t work…

For the 3rd year in a row the life expectancy in the US has declined. Why? A major contributor is the opioid crisis. In the past 20 years it has claimed 400,000 lives in the US and now, in the UK and the US, the odds of dying from an opioid overdose far exceed the odds from dying in a vehicle crash.

Overdose deaths in preceding 12 months

Source: CDC

How has this happened and what can be done about it?
The perfect conditions have been created: Pharmaceutical companies have been using aggressive marketing techniques, mix that with the enthusiasm of certain medical professionals to prescribe, and add in a lack of reporting of suspicious orders by representatives and pharmacies. Suddenly it’s simple to see why ordinary people are becoming addicted to these powerful drugs. For many, what starts as a genuine need for pain relief escalated into full blown addiction and a progression to harder illegal drugs. This is not the first time the pharmaceutical industry has got into hot water over its sales strategies (e.g. see recent article on Insulin prices, here and here.)

What is happening about this?
Currently in the US there are 22 opioid makers, distributors and pharmacies trying to negotiate settlements with 2000 municipalities pursuing them. It is expected that one of the cases being brought in Ohio by means of a “negotiation class” in October will have a significant impact on those negotiations and future legal actions.

Some well-known names have been caught up in all this. Johnson and Johnson was recently ruled as a “public nuisance” by an Oklahoma judge and ordered to pay $572mequivalent to a year’s worth of services needed to combat the epidemic in Oklahoma. Reckitt Benckiser agreed to pay a $1.4bn settlement with the Department of Justice and the Federal Trade Commission over the way a subsidiary marketed a painkiller.

Until recently, you probably wouldn’t have heard of Purdue Pharmaceutical. But as the manufacturer of OxyContin, Purdue is one of the biggest players in this whole situation. The company previously settled with the Department of Justice over aggressive marketing techniques in 2007. Unfortunately, it seems the leopard did not change its spots. Purdue is accused of continuing to market OxyContin as having lower addiction risk than other opioids, with drug salespeople aggressively remunerated.  Purdue owners, the billionaire Sackler family, have found their philanthropic activities increasingly in the spotlight.

A few weeks ago Purdue filed for bankruptcy and established a framework agreement with 27 states to set up a new company that will continue to sell OxyContin but with all proceeds going to the plaintiffs. The Sackler family themselves will have to contribute $3bn cash with the entire settlement being worth somewhere in the region of $10-12bn… albeit with no admission of wrongdoing.

The sums are enormous. But still small in comparison to the estimated total “economic burden” of prescription opioid misuse in the United States.

The estimated cost of Opioid misuse in the US currently sits at a staggering $78.5 billion a year, including the costs of healthcare, lost productivity, addiction treatment, and criminal justice involvement.

About the author

Miranda Beacham is Corporate Governance Manager in the ESG Research team. She is responsible for monitoring, engaging and voting of investee companies in line with our Responsible Investment Policy. She joined us in 1994 as a research assistant in the UK equity team and has 25 years’ industry experience (as at 30 April 2019). Miranda studied Chemistry at Napier University and has the IMC professional qualification.

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#Flightshame

The airline industry doesn’t really have a plan or immediate technological solution to address its climate impact. Currently, flying accounts for only 2.4% of global CO2 emissions. The problem is passenger numbers are projected to double to 8.2 billion by 2037, and at this rate it could consume a quarter of the carbon budgeted to limit the global temperature increase to 1.5C by 2050 (Carbon Brief).

Factors affecting the emissions intensity of an airline include fleet age, seat density/passenger load (well done Ryanair, but you were still Europe’s 10th largest polluter in 2018), and the mix of long-haul versus short-haul routes. Fuel typically comprises 25% of an airline’s operating expense, so there is a massive incentive to increase fuel efficiency. Airlines have managed to make considerable progress in reducing emissions by improving the efficiency of their aircraft, but this is dwarfed by increasing demand.

It’s convenient to dismiss ‘flygskam’ or #flightshame as virtue signalling. But consider how societal concerns regarding plastic have shifted radically and in short order. Air travel is on track to become the new coal within three decades if the predicted cuts in other sectors materialise. Flying accounts for 17% of an average household’s greenhouse gas emissions, but the real problem lies with the 10% of us who take four or more flights each year.

Short-term, the industry is pitching carbon offsets as a partial solution. From 2021, CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation) will require participants to offset their emissions. All airlines which operate between two volunteering states will be subject to offsetting requirements.  As of January 2019, 78 countries had volunteered to participate, including the US, UK, and Saudi Arabia (but not China, Brazil or India).  The carbon offsetting business is probably a good place to be right now, though the scientific merit of the approach is often questioned.

Material technological solutions are some way off. Alternative fuels may be part of the solution – fuel-electric hybrid technologies appear closest (late 2020’s) and UBS estimate that fuel costs could be reduced by as much as 40% versus a conventional aircraft, even allowing for higher battery costs and ground handling fees.

We have previously talked about climate tipping points. The industry risks being singled out more and more as other industries reduce their emissions. This probably means greater risk of taxation, a quick and easy solution beloved by governments. France recently imposed a new ‘eco-tax’ on all airline tickets for flights departing from French metropolitan airports by 2020. Aviation is critical in fostering economic growth, connecting businesses and travellers, providing important tourist income and supporting humanitarian missions. But as Richard Gustafson, CEO of Scandinavian Airlines (SAS) recently stated, climate change undoubtedly presents, “an existential question”.

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.  *As at 30 April 2019.

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Oil boycott…or not?

Oil, huh, good god
What’s it good for
Absolutely nothing, listen to me…
https://www.youtube.com/watch?v=dpWmlRNfLck

The recent drone strike on Saudi Aramco’s Abqaiq oil facility caused Brent crude prices to briefly spike over 20% on anticipated short supply. In the end the outage appears manageable but the market reaction was not surprising, with an estimated 5% of global supply offline. So normal service has resumed but it does remind us of our dependence on the black stuff.

Some commentators have fast forwarded to a future without oil… get rid of oil, aside from the environmental benefits, we’ll get less war, less tyranny, less arms deals… sounds good.

Not least because oil has had a hugely distorting effect on economies in the Middle East.  Kingdoms have had access to billions of gallons of light sweet crude through happenstance of geology rather than foresight. The resulting wealth has accrued to elites, with the tacit agreement that the status quo is maintained through services such as the provision of free education and healthcare.

There doesn’t seem to be anything sustainable about all of that. So the expected displacement of oil by renewable sources of energy should be a thing to celebrate. Not so fast, consider the destabilising impact this will have – just consider that the youth is 60% of the Arab population, and they will need to find meaningful employment.

These are currently wealthy countries, for example Saudi Arabia’s debt to GDP is only expected to rise to 25% by 2021. Its budget deficit is forecast by the IMF to rise to 7% of GDP this year. Oil is 12% of GDP for the UAE but for Libya over 50%, Norway’s is only 3%! This is not sustainable, so there is a race to invest and modernise. This will require structural changes to society if there is any hope of delivering the jobs that the population will need to sustain their prosperity.

 

This is not lost on governments they are investing billions of dollars to deliver a sustainable future; Qatar’s 14 sq km “Education City” on the outskirts of Doha, Saudi Arabia has been investing in its National Science, Technology and Innovation Plan (NSTIP).  It is a mammoth task, in a region that has struggled with decades of instability more challenge seems desperately unfair.

These are massive sustainability challenges for the region and the world – highlighted by the blinding glare of technological progress.  Solutions such renewable energy and storage solutions are key in addressing our climate challenges, let’s also hope that they lead to a better world for all.

 

About the author

Jonathan Parsons is an Investment Manager in the Equities team with responsibility for North American equities. He also manages a global technology portfolio and contributes to the idea generation process for our global equity portfolios. Prior to this, he worked as a Quantitative Analyst, also in the International Equities team. Jonathan joined us in 1996 straight from university and has 23 years’ industry experience*. Jonathan studied Mathematics & Computation at Loughborough University of Technology and is a CFA charterholder.  *As at 30 April 2019.

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#ClimateCrisis/GDP=#DIV/0!

Today we’re witnessing a global Climate Strike led primarily by children because – according to science – the future of our planet is in peril. So it’s probably a good time to ask why most of us are willing to carry on our daily lives as normal. I don’t mean to be melodramatic here… it’s a genuine question. We are all guilty parties and my behaviours are probably no better than the average developed market human (i.e. bad).

Is it wilful ignorance? Is it political intransigence? Or is it corporate conspiracy and media manipulation that prevents change?  Some studies in behavioural psychology indicate that being able to ignore or suppress the really bad stuff is a helpful evolutionary trait. It helps protect us against hopelessness and depression. Perhaps it’s that!  But what if it’s not about ignorant politicians, propaganda or evolutionary mental health? What if it is just about time? I mean to say, that what if the future just doesn’t cost us very much?

Catastrophic climate breakdown imminent…..

The legendary investor and environmental campaigner Jeremy Grantham calls this “the tyranny of the discount rate”.  What does he mean by this? It’s a way of saying that by systematically discounting the value of each future year, we are making it less important. And this is a tyranny because it engenders a kind of future blindness.  When we are dealing with multi-decade or multi-century problems, our reaction is kind of… ¯\_(ツ)_/¯

We live in a world largely measured on the wrong short-term measures of value. I addressed this in GDP’s Dirty Little Secret, because this measure of human economic prosperity is clearly not fit for purpose. But when measuring the value of human achievement according to this measure you suddenly learn that human achievement is apparently worthless. Worth nothing! Not less than it should be or shockingly little….. N-O-T-H-I-N-G! The arithmetic is very simple, and it plays out in the chart below.


Source: Source: Kames Capital. * World Bank global GDP estimate of $84.8 trillion US dollars in 2018

On this economic basis, the economic value of my future grandchildren is literally inconsequential today. The history of our planet is measured in billions of years, yet the future value of its current economic output is worth zero in the blink of a geographer’s eye.

Climate catastrophe according to economists

Imagine this global protest against climate change shut down air travel for one week. Imagine that it cost airlines $6.5 billion in lost revenue (3 million flights a day x $300 a ticket). Imagine the second order multiplier effect on business and consumers worldwide amounted to 80 times that cost (a wild exaggeration). The lost GDP now with 100% probability and zero discounting applied would be $526.5bn. There would be a lot of angry people out there. Very angry! But ultimately, this is one week of lost air travel and we would survive it.

But then imagine there is a 90% probability of catastrophic climate breakdown in 50 years. And imagine that the estimated cost of that catastrophe is 50% of global GDP. This is “apocalyptic-nightmare-end-of-civilisation-and-perhaps-our-species” type stuff. Yet, discounted at 8%, this future event only costs us $540 billion in today’s terms. The same as the hypothetical air travel strike above. That’s about half the market value of Apple Inc. today or 0.6% of global GDP. And if catastrophic climate breakdown can be pushed out another 50 years by buying electric cars and eating less meat, that particular catastrophic climate breakdown is only worth $8.4bn in 2019 or 0.001% of today’s GDP. Just a few years on from that and the cost of climate breakdown / GDP = #DIV/0!

 In defiance of tyranny

“The market mechanism does not solve for the appropriate allocation of attention when everything is seen through the lens of capital. Human history is littered with misallocation of attention.  From the Aztecs to Easter Island, we have a habit of being distracted and seeing the scale of a problem too late”   Albert Wenger (Investor & Author of World After Capital)

We are guilty as charged. But whilst children strike, we’ll try to do our (tiny) bit by allocating our client’s capital as sustainably as we can and shouting about it from our small soapbox. We will try to back companies which we think have the best chance of disrupting the status quo and pivoting us to a non-catastrophic (and perhaps even wonderful) future beyond the next quarterly reporting season. But let’s be realistic, this tyranny of future blindness that we have built for ourselves needs an overhaul. Our species is having more impact on the world than any other in the last 4.5 billion years. We need a new framework for thinking about the future costs of the damage being done today. One which is measured in geologic rather than socioeconomic timescales. Our current decision making system which is anchored to a flawed concept of economic value and discounted to nothing in a human lifetime is not it. But neither is anarchy. Anyone got any good ideas? I’m thinking they probably need to be radical, collaborative and disruptive.

#ClimateStrike

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.

He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience.

*As at 30 April 2019.

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‘Just call me Paul….’

I went to a conference recently where a member of one of the UK security agencies was speaking – he couldn’t give his name, no photographs were allowed, no mention on social media and he could not be further than 6 feet away from his laptop at any time. My interest was piqued!

It was like something out of Spooks! Immediately I envisioned shifty characters skulking around in the shadows trying to steal official secrets from hapless civil servants – however, the reality is far from it. While some well publicised leaks come from carelessly leaving laptops in public places, or being photographed with sensitive data on clearly visible paperwork, that’s not the biggest danger. What is? Sophisticated cyber-attacks.

“Paul” regaled us with tales of poor passwords and cyber snooping through family member’s social media along with people plugging in dropped memory sticks to computers. I know, you’ve heard all this before, but there are instances of companies in a takeover process being completely stripped of their intellectual property before a deal is done!

You only have to open the paper to see it. The press is full of worrying data breaches at well-known companies – in the past year we have seen this everywhere, from the financial sector to airlines to supermarkets to the London Tube – investors therefore need to address cyber security with the companies they invest in.

In fact, it’s estimated that sophisticated techniques used by hostile states pass down into organised crime in around 6 years. So it makes sense to listen to the security agencies when they advise us on what we should be asking boards of investee companies. Cyber security is being addressed at a national level both in the UK and US – most recently the US has introduced the US Cybersecurity Disclosure Act requiring listed companies to disclose (in public filings) whether any of the board members are considered to be a cyber security expert.

The discussions we have with boards of the companies we invest in include: how they identify their most valuable assets whether that be physical or intellectual, how they identify the threats to those assets and how they adapt a risk management programme to deal with those threats. We are interested at what level within the organisation these issues are considered at, whether there is sufficient expertise on the board to understand them and how often the company tests their defences and how they learn from incidents.

It’s not perfect; we aren’t able to attend board meetings. However, by addressing this issue with companies when we have the opportunity, we hope it encourages them to start having serious discussions around the board table.

About the author

Miranda Beacham is Corporate Governance Manager in the ESG Research team. She is responsible for monitoring, engaging and voting of investee companies in line with our Responsible Investment Policy. She joined us in 1994 as a research assistant in the UK equity team and has 25 years’ industry experience*. Miranda studied Chemistry at Napier University and has the IMC professional qualification.

*As at 30 April 2019.

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Insulin prices in America. What the……!? (Part 2)

In last week’s blog (Part 1) we tried to answer the complex question of what is flawed with current insulin pricing system in America. But that left out one vital bit- the why. This week I want to explain why it is so dysfunctional and how the forces at play – given the wonder tyranny of compounding – are so opaque in the short term, yet so aggressively malevolent over the long-term.

Inverted Incentives
Let’s cut to the chase. A reduced rebate rake on a very big market generates much more revenue than an increased rake on a small market. Think about that. This means Pharmacy Benefit Managers (PBMs) are incentivised to increase the size of the market and the best way to do this is by allowing price rises. Yes, you read that correctly – the party designated to negotiate prices down, benefits from prices going up! And this is not a socialist conspiracy theory, this is widely recognised by the sell-side analyst community:

“The rebate basis of the system has a fundamental conflict of interest which has perversely encouraged high list prices for drugs (and concomitant price increases)…. Thus the theoretical fiscal sweet spot for PBMs are high priced drugs, with high rebates and high co-pays….[this is the] “frictional costs” in the drug pricing ecosystem as money (ultimately) paid by the “society” for drugs that do not end up as revenues for Biopharma companies.

-Analyst, Evercore ISI

A Case of Compound (Self) Interest
Why has this been allowed to happen?  We could stop here and just blame lobbyists but that would be too easy. Fundamentally, it happens because the slow-acting and pernicious effects of compounded inflation falls under the radar in the short term. And most things are managed on the short-term. The average human generally struggles to comprehend the non-linear power of compounding, so how can we expect politicians – managing a short-term electoral cycle and influenced by well-funded lobbyists – to fare any better?

I have built a quick model to show how the math works and the chart below is the output. I have used the real price rises per vial of insulin. To show the extent of the inverted incentives, I have assumed the drug price discount actually increases from 50% to 70% and that the PBM rake declines from 20% to 15%. Despite these ‘improving’ terms, the compounding effect of the annual price increases still mean that the revenue growth for drug companies and PBMs is inordinately large.

Insulin prices: Company revenue share & patient costs


Source: Kames Capital
Note: General US inflation between 1997 and 2017 has been +55.6% or a compund annual rate of 2.2%
CAGR = Compound annual growth rate
Vial = 10ml or 1000 units (approx 1.5 vials used per month on average)

The illusion of ‘improved’ terms offered by drug suppliers and PBMs is very important for this political narrative. Mr Machiavelli would be impressed. They can point to these as proof that they are ‘doing their best’. Short-term discounts and reduced rebates rakes are much more intuitive than non-linear compound interest.  Drug makers and PBMs can reasonably claim to be offering bigger percentage discounts and taking lower percentage rebates rakes, all while seeing their revenues, patient prices and the frictional costs paid by society grow massively.

Conclusion: Societal Friction Leads to Disruptive Innovation
This is a remarkable system and a sorry state of affairs, however I believe the historic ‘market forces’ narrative behind the current US healthcare system is running out of road. The statistics have been conflated for too long. The absolute dollar burden on society – not to mention the very real and painful costs to individuals that are so often wilfully overlooked – is becoming too large to ignore. Value based care. Regulation. Populist revolts. I believe these will increasingly pressure the valuations, revenues and cash flows of the companies that have been systematically over-earning from patients and society. The duplicity will become common knowledge. But it won’t stop there.

Disruptive innovation is naturally attracted to such problems and it is here that market forces still have a say. The outrageous frictions caused by a rigged system ultimately create opportunities for mission orientated disruptive entrepreneurs. Indeed, we are already seeing numerous young and innovative companies challenging the norm and leveraging technology to provide better and more cost-effective outcomes for patients. These types of companies have eminently more sustainable business models and are the ones that I think will be the long-term winners in the health care space. They will be supported by those advocating change.

It is undoubtedly true that the change cannot come quickly enough. Sadly, it is too late for many but in the words of Sam Cooke, ‘A Change Is Gonna Come!’ Actually, that would have been a good title for this blog too – and a much more positive one.

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.

He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience (as at 30 April 2019).

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