By Michael Brush
Want to improve your investment performance? Then cut through the noise and take a moment to learn the essentials from among the best in the business.
In this spirit, I recently caught up with Neal Kaufman, who manages the Baron Health Care Fund /zigman2/quotes/207375621/realtime BHCFX +1.15% .
In its short three-year lifespan, the mutual fund is shooting out the lights. The fund crushes its S&P 1500 Health Care index benchmark and health-care category by more than 12 percentage points, annualized, over the past three years, according to Morningstar.
Here’s a table from Morningstar showing calendar-year returns and rankings through Oct. 11.
How does Kaufman get those returns? He cites five principles that guide him in stock selection. Here’s a review, with company examples.
#1. Look for open-ended growth opportunities
One of the core tenets at New York-based Baron Capital is to invest in companies selling into large and expanding markets, says Kaufman.
That’s the case with a medical-device company called DexCom /zigman2/quotes/201324608/composite DXCM -0.36% . It offers continuous glucose monitors for diabetics. The company’s G6 monitor is convenient because it eliminates the need for finger sticks. The monitor sends readouts to smartphones, providing alerts of dangerously high or low blood sugar levels.
Unfortunately, diabetes is on the rise, in part because of the obesity epidemic. By 2045, the number of people in the world with diabetes will increase over 50%, compared to 2019, to 700 million, predicts the International Diabetes Federation. Diabetes is the seventh-leading cause of death by disease in the United States, says the Centers for Disease Control and Prevention. DexCom is in the process of getting regulatory approval for an upgraded version of its device called the G7.
#2. Ride the secular tailwinds
In investing, “secular” refers to business trends that aren’t vulnerable to changes in the economic cycle. Catching secular trends is another core investing principle at Baron Capital. There are lots of secular trends in health care. One is the adoption of minimally invasive surgery.
This is preferable because it reduces blood loss during surgery, and pain levels during recovery. Baron Health Care owns two companies in this space: Intuitive Surgical /zigman2/quotes/204935713/composite ISRG +4.89% , which sells robots that help with surgery, and Edwards Lifesciences /zigman2/quotes/205745196/composite EW +1.52% , which offers a system that helps doctors perform less invasive aortic valve replacement.
#3. Invest in companies with a durable competitive advantage
This one comes up so often among outperforming managers, from Warren Buffett on down, that it’s a “must have” on your list of qualities to look for at companies.
Protective moats give companies coveted pricing power. And, of course, by definition, they protect market share. Companies attain moats via strong brands, superior technology, leadership in a sector, a large installed base that elevates switching costs, or services that benefit from the “network effect.” This means the more people use a service, the more valuable it becomes to everyone in the network. Think social media platforms.
For moats, Kaufman cites Guardant Health /zigman2/quotes/201348336/composite GH -1.23% , a market leader in liquid biopsies, or the use of genetic sequencing to detect signs of cancer in blood samples. Guardant earns a moat because of its technology platform, regulatory approvals and solid reimbursement profile among insurers. Intuitive Surgical is another example, because of its innovative technology, large installed base and regulatory approvals.
Also consider Schrodinger /zigman2/quotes/216289964/composite SDGR -0.23% , which offers software that interprets the physics of drug molecules to predict how they might tweak body chemistry to treat diseases.