* Health segment makes up increasing slice of SWF portfolios
$5.6 bln invested in 9 months to Sept -SWF Institute
* Rising healthcare costs spur innovation
By Claire Milhench
LONDON, Oct 6 (Reuters) - Imagine contact lenses that monitor glucose levels for diabetics, tiny implants to tackle chronic diseases, or algorithms that crunch data to predict illness rates.
Rather than science fiction, these are examples of cutting-edge research being pioneered by biotech firms seeking to revolutionize healthcare from cradle to grave.
Such work tends to be highly expensive and can take years to pay off -- which makes it a good fit for deep-pocketed sovereign wealth and pension funds that can afford to tie up capital for a long time.
Shares in big pharmaceutical and healthcare companies still appeal for their steady returns. But sovereign funds are increasingly tapping private markets, hoping that early investments in small firms will at some stage yield outsize returns.
Their direct investments in healthcare totalled $5.58 billion in the year to mid-September, Sovereign Wealth Fund Institute data show, up from $2.15 billion in the first three quarters of 2016.
Pressure on the healthcare industry to innovate is enormous.
Western governments need to reduce the crippling burden on public finances of aging populations, with Deloitte forecasting that the global healthcare spend will reach $8.7 trillion by 2020.
And limited state provision in emerging markets means costs there need to come down so more people can afford treatment.
"Healthcare is a basic product that someone has to provide and there's a mega-trend globally there is still a tailwind from aging demographics," said Markus Massi, a senior partner at Boston Consulting Group (BCG).
BCG data shows healthcare makes up 13 percent of sovereign wealth fund (SWF) portfolios with 54 deals expected in 2017, a five-fold rise from 2012.
Singapore's Temasek set the bar this year with an $800 million investment in Verily, Alphabet Inc's life sciences business.
It followed that with an investment in Coherus Biosciences, which is developing biosimilar drugs - cheaper versions of pricey biotech drugs used to treat diseases including cancer and rheumatoid arthritis.
Investments by Ireland's Strategic Investment Fund (ISIF), which has about 10 percent of its Irish portfolio in healthcare, include GMI, a start-up studying genetic and lifestyle factors involved in disease.
"Ireland is a recognized hub for life sciences and has many high growth, high potential companies that are capable of competing globally," said Eugene O'Callaghan, director of ISIF.
Such investments can prove highly profitable. According to media reports, ISIF made nine times what it invested in medtech company Neuravi when it sold in April.
The focus on healthcare goes hand-in-glove with SWFs' longer-term tilt towards private markets following disappointing performance in listed securities in recent years.
Pascal Heberling, who heads the healthcare unit at Abu Dhabi Investment Authority's (ADIA) private equity group, says it makes several investments each year in areas including generic drugs and medical devices.
An example, alongside Singapore's GIC, was an investment in drug-testing firm Pharmaceutical Product Development .
Smaller SWFs tend to invest via specialist vehicles -- in 2016, the Oman Investment Fund put money into Cambridge Innovation Capital, which commercializes technology and healthcare research from Cambridge University.
"There has been a boom in R&D over the last five years with venture capital funds backing the work that is coming out of universities, helping develop new treatments," Heberling said.
In emerging markets, investing privately can be the only option because of the paucity of listed healthcare stocks big enough to take SWF money.
Limited state provision has also left a gap for others to step into.
In Brazil, despite the country's recent economic problems, ADIA's Heberling said healthcare had performed strongly. He declined to name specific ADIA investments but cited capitation models, whereby a company provides healthcare for employees by contracting with a chain of clinics.
Data from industry body EMPEA showed healthcare deals in emerging markets hit their highest half-year totals on record this June, with 74 completed and $1.8 billion invested.
Hospitals and specialist clinics in the developing world are also luring SWFs for their reliable returns.
"The middle classes in emerging markets require much better hospital services than they are provided with in the public sector," said Javier Capape, a director at the Sovereign Wealth Lab at Madrid's IE Business School.
Singapore's GIC has invested directly in hospital chains in India and the Philippines, while Malaysia's Khazanah has invested in healthcare groups active in Turkey and Bulgaria.
And the Russian Direct Investment Fund has just teamed up with Interhealth Saudi Arabia to invest in the construction of a high-tech pediatric center in Tatarstan.
New Zealand's Superannuation Fund (NZSF) is focusing on retirement care. It has a near 20 percent stake in retirement village provider Metlifecare and a 50 percent stake in RetireAustralia.
Many baby boomers, the population cohort roughly born between 1945-1965, can afford more upmarket accommodation, and have higher expectations, than their parents.
"We are living longer, getting older, and we have more demands as we are getting wealthier," said NZSF's chief executive Adrian Orr. "People are prepared to spend more and more money on health ... It is impossible to think that governments themselves can cover these things."
(Reporting by Claire Milhench; additional reporting by Anshuman Daga and Olzhas Auyezov; editing by John Stonestreet)