Health Care’s Underperformance Sets the Stage
We believe Health Care currently offers some of the most attractive secular growth opportunities in U.S. equities, particularly given low absolute and relative valuations. Nowhere is this more evident than in Biotech, which we view as the most compelling subsector given its innovation, valuation reset, and renewed growth outlook following a multi-year bear market. Over the past year, generalist investors used Health Care as a funding source to chase the AI-driven technology boom and more cyclical sectors, leaving the group as the worst-performing sector year-to-date. In our view, the pendulum has swung too far, and we are now finding opportunities to own some of the most innovative growth companies at appealing entry points.
We see Health Care as a prime candidate for rotation, offering one of the largest potential recovery opportunities across equities. While we do not expect a sharp V-bottom recovery, we anticipate a steady grind higher as investors climb the “walls of worry.” Should leadership in other market winners fade, we believe Health Care could surprise to the upside. Importantly, even in a protracted recovery, we continue to find compelling opportunities across subsectors, a backdrop that we think favors active management.
Chart: Health Care Stocks are Trading at Compelling Valuations
Source: Westfield, FactSet, based on data for trailing 5-years ending 6/30/2025 for the XLV vs the S&P 500 index.
Health Care Positioned for Recovery
The start of 2025 brought signs of life. On the back of a few M&A deals and outsized clinical readouts, it initially appeared that Biotech was beginning to emerge from a four-year bear market. Yet enthusiasm quickly faded as macro pressures and micro concerns resurfaced. A “higher-for-longer” rates mentality weighed on sentiment, and a perception of disruption at the FDA exacerbated uncertainty. We believe these issues do not materially change asset intrinsic value, but they contributed to renewed outflows in a fragile liquidity environment.
Concerns escalated in the spring around tariff and “Most Favored Nation” (MFN) rhetoric from Washington. MFN has long been a fear for investors, but in our view, it remains highly complex to implement and unlikely to materially alter near-term valuations.
Across subsectors, performance diverged:
- Biotech: Fundamentals are improving, with well-capitalized companies advancing to late-stage trials, yet valuations remain depressed.
- Pharma: Tariff/MFN fears and concerns of a price war in obesity drugs dampened sentiment.
- Services: Sentiment weakened around managed care, particularly following utilization spikes and pricing missteps, while distributors provided relative stability.
- Tools & Diagnostics: NIH funding cuts and a slow biopharma funding cycle constrained recovery.
- Medtech: The group held up better but faced tariff concerns tied to non-U.S. supply chains.
Innovation as a Catalyst
We believe innovation is the lifeblood of Health Care, and the sector is at an inflection point. Winners, in our opinion, will be those delivering measurable improvements in patient outcomes, provider efficiency, and system-wide cost savings.
One of the most exciting areas, in our view, is AI in drug development. The benefits are multi-dimensional:
- Improved Probability of Success: AI can help design best-in-class and first-in-class molecules.
- Time Savings: Early studies suggest up to a 30% reduction in development timelines.
- Cost Savings: Preclinical cost reductions of 60–65% are possible; even a conservative 10% savings on ~$260B in R&D could lift sector ROE by ~50bps.
- Increased Approvals: A 2.5% improvement in preclinical success could mean 30+ new drug approvals over 10 years (Morgan Stanley Research, 9/4/25).
Chart: AI’s Impact on Drug Development
Source: Morgan Stanley Research, as of 9/4/2025
Demographics Create Structural Tailwinds
We believe demographics represent one of the most powerful secular drivers of Health Care. The U.S. population is aging, living longer, and consuming more health care. Costs are projected to reach $8.6 trillion by 2033, intensifying pressure on an already strained system.
This trend, in our view, makes innovation not optional but necessary. Solutions must improve outcomes while lowering costs across the ecosystem. When evaluating opportunities, we focus on two key questions:
- What unmet need is being addressed?
- How much of an advancement over the current standard of care does the solution provide?
If those answers are compelling, we believe the downstream benefits — for patients, providers, payors, and investors — are often significant.
Chart: Rising U.S. Health Care Costs Requires Innovative Solutions
Source: Morgan Stanley Research, as of 9/4/2025
Biotech and Medtech Lead the Way
We believe Biotech is the most attractive subsector within Health Care, supported by innovation, strategic relevance, and valuations that remain at multi-decade lows. Medtech also provides complementary long-term growth opportunities, though on a smaller scale. In contrast, concerns around policy changes, site-of-care costs, and Medicaid redeterminations have us more cautious on Health Care Providers and hospitals in particular.
Biotech: Positioned for Leadership
We view Biotech as the most attractive area of Health Care over the next 5–10 years. It combines innovation, growth, attractive valuations, and tariff insulation. Most importantly, we believe strategic buyers will increasingly turn to Biotech for acquisitions as large Pharma faces acute patent expirations and a less supportive U.S. policy environment, creating one of the most favorable M&A backdrops in years.
Innovation & Clinical Progress
- During the biotech drawdown that began in early 2021, many companies were sufficiently capitalized to make tremendous progress in the clinic.
- High-quality assets moved from Phase 1 through Phase 3, successfully navigated the regulatory landscape, and have resulted in new product launches that are exceeding investor expectations.
- We believe the space is much more mature today than it was four years ago, and many valuations (although improving) are not yet reflecting the transformation of these companies.
- In our view, newly commercial names that are approaching or already generating profits remain significantly undervalued, with Street estimates underappreciating the long-term trajectory of their launches.
Insulation: Tariff-Resistant & Strategic Priority
- Drugs and biologics are largely exempt from tariffs, and U.S.-based IP and manufacturing provide structural advantages.
- Biotech is increasingly seen as a national security asset, which has resulted in strong policy support for onshoring and R&D investment.
Opportunities: M&A, Interest Rates & Valuations
- Global M&A Magnet: Large Pharma’s revenue needs are becoming more acute, and with a valuation reset in high-quality assets, we believe M&A activity will accelerate. The perception of a more lenient FTC has further supported deal flow.
- Rate-Sensitive Rebound: We believe biotech stands to benefit disproportionately from lower rates given its financing sensitivity, making it a likely beneficiary of any rotation into high-duration innovation.
- Alpha in Mispriced Assets: Biotech has lagged badly in recent years, leaving valuations at multi-decade lows. We see meaningful catch-up potential as investor flows rotate back into under-owned segments of the sector.
Medtech
As it relates to Medtech, we view this subsector as being comprised of high-growth companies with large total addressable markets.
- We favor high-margin, high-growth leaders targeting large, underpenetrated markets.
- Key focus areas include minimally invasive surgery, GLP-1 and obesity/diabetes therapies.
- Companies in diabetes care, patient monitoring, and connected devices highlight the innovation we believe will expand both access and profitability in the years ahead. For example, AI-driven platforms in patient monitoring are beginning to show how technology can materially expand margins while improving outcomes.
Chart: Biotech Weakness Sets the Stage for Catch-Up
Source: FactSet, as of 8/25/2025
Policy and Regulation: Headline Risk vs. Reality
Policy risk is a constant headline, but we believe reality is more constructive than rhetoric suggests.
The FDA, in our view, has proven efficient and transparent, with approvals largely on time and advisory panel counts at multi-decade lows. In some cases, development pathways are even being streamlined — such as easing animal testing requirements.
Drug pricing remains a populist talking point, but implementation is complex. MFN rhetoric, while headline-grabbing, remains more bark than bite in our opinion. We also see potential for more upward pressure on ex-U.S. pricing than downward pressure domestically.
Additional regulatory debates, such as limits on direct-to-consumer (DTC) advertising, are worth watching. We believe exposure is concentrated in markets with high competition and reliance on advertising, such as vertically integrated telehealth providers. By contrast, in our view, innovative assets in rare disease and specialty care are less exposed.
Conclusion: From Laggard to Leader
Fear and rhetoric have weighed heavily on Health Care equities, but we believe this has created a compelling entry point. With valuations at multi-year lows, pipelines maturing, and secular drivers intact — demographics, innovation, and M&A — the sector is, in our view, positioned for a multi-year recovery. We view Biotech as the most attractive subsector and expect it to lead this transition, supported by breakthrough innovation, tariff insulation, and robust strategic M&A as large Pharma addresses looming patent cliffs. Medtech also offers compelling opportunities, particularly in obesity, diabetes, and patient monitoring. Taken together, we believe Health Care is poised to move from sector laggard to long-term leader, offering investors a unique combination of growth, defensiveness, and opportunity.
Important Disclosures
The views expressed are those of Westfield Capital Management Company, L.P. as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable.
Past performance is not indicative of future results.
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