Just What the Doctor Ordered: Healthcare and Biotech ETF Review
Don Dion
Don's Investment Newsletter: Don's Asset Management Business:
There haven’t been many places for equity investors to hide over the past few months. Since hitting their highs in October of last year, the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite Index have all entered bear market territory; the financial sector is still grappling with tight credit conditions and a looming wave of Alt-A mortgage defaults; and even the commodities juggernaut has faltered in recent weeks.
When the markets turn volatile, investors tend to get defensive, heading for cash, fixed income funds and classic defensive sectors such as utilities, consumer staples and, of course, health care. While health care stocks have historically held up well during market downturns and periods of slow or negative economic growth, the sector is also a good place to be for investors looking for significant capital appreciation over the long term. This vast and varied category includes pharmaceutical and biotechnology companies, medical equipment manufacturers and health insurers. As the baby boom generation enters retirement, the future for the health care sector looks bright.
According to the Centers for Medicare and Medicaid Services, health care spending in the U.S. was $2.3 trillion in 2007, or $7,439 per person—approximately 16 percent of GDP. By the time the first wave of baby boomers reaches age 72 in 2017, health care spending will be $4.3 trillion, or 19.5 percent of GDP.
ETF sponsors have developed a wide variety of options for health care investors. Not surprisingly, iShares features the most complete lineup of funds, all of which we track in the ETF Report. Of the four funds based on Dow Jones indexes—the Dow Jones U.S. Healthcare Sector Index Fund (IYH), the Dow Jones U.S. Healthcare Providers Index Fund (IHF), the Dow Jones U.S. Medical Devices Index Fund (IHI) and the Dow Jones U.S. Pharmaceuticals Index Fund (IHE)—IHI has been the best performer this year, thanks to strong earnings and profit forecasts from top holdings Medtronic (MDT), Thermo Fisher Scientific (TMO) and Covidien (COV).
The weak dollar has been particularly beneficial to the U.S. medical device subsector. For instance, Thermo Fisher, a leading manufacturer of laboratory equipment, reported that “currency translation” increased its second-quarter revenue by 4 percent. For Covidien, the weak dollar added 5 percent to its most recent quarterly sales tally and helped boost profit margins by 1.5 percent over the same period a year ago.
The laggard among iShares’ U.S. health care sector ETFs so far this year has been IHF, a fund of medical insurance companies, private hospital chains and pharmacy benefit managers. From the beginning of the year through August 5, IHF declined 21.6 percent. Although this fund is well off the year-to-date low it hit on July 15 ($42.79 a share), investors remain dubious about the profitability of U.S. health care providers. Presumptive Democratic presidential candidate Barack Obama has made universal health care a central plank of his campaign platform, and many industry analysts believe that implementing such a plan would ultimately force the big health insurers to abandon some of their largest markets.
For biotechnology investors, iShares sponsors the Nasdaq Biotechnology Index Fund (IBB). Some of the most promising new drugs—including innovative treatments for cancer and AIDS—are coming out of the notoriously volatile biotech sector. Swiss drugmaker Roche (RHHBY.PK) announced last month that it would make a cash offer before the end of the year to acquire the remaining shares of biotech giant Genentech (DNA) that it doesn’t already own. The prospect of a wave of mergers sweeping the sector has piqued investor interest in IBB, which was up 10.2 percent on the year through August 5.
Rounding out the iShares health care ETF lineup is the S&P Global Healthcare Sector Index Fund (IXJ). Investors looking for pure overseas, i.e., ex-U.S., exposure should know that IXJ holds a number of American pharmaceutical and biotech stocks, including Johnson & Johnson (JNJ), Pfizer (PFE), Abbott Laboratories (ABT), Merck (MRK) and Amgen (AMGN). All of the iShares health care sector funds carry an annual expense ratio of 0.48 percent.
For investors looking to avoid U.S. firms, WisdomTree’s International Health Care Sector Fund (DBR) provides extensive coverage of the Japanese, Swiss and U.K. pharmaceutical sectors (drug companies accounted for nearly three-fourths of DBR’s assets as of early August). As most ETF investors know, WisdomTree was an early pioneer of fundamentally weighted funds; the firm’s proprietary International Health Care Sector Index is weighted based on regular cash dividends paid.
WisdomTree (WSDT.PK) makes a compelling case for its fundamentally weighted funds in its marketing materials, but how does DBR actually stack up against its peers? Through August 5 of this year, DBR had declined 1.6 percent, while the iShares S&P Global Healthcare Sector Index Fund (IXJ) had lost 3.6 percent.
Finally, PowerShares sponsors two funds: the Dynamic Pharmaceuticals Portfolio (PJP) and the Dynamic Biotech & Genome Portfolio (PBE). Both funds are based on PowerShares’ proprietary multi-factor “intellidex” indexing methodology, which is designed to identify and assemble a portfolio of stocks with the greatest potential for outperformance.
In relative terms, PJP appears to be delivering on its promise of outperformance. This fund has declined about 4 percent so far this year, while the comparable iShares product, IHE, is off just over 7 percent during the same period.
In the biotech space, however, the PowerShares fund comes up short. The iShares biotech fund, IBB (up more than 10 percent on the year), is outpacing PBE, which was up 6.8 percent through August 5.
A quick note on the HealthShares funds, the “vertically screened” ETFs that target tiny subsectors of the health care space, such as ophthalmology and cardiology: According to recent data compiled by the folks at Bespoke Investment Group, 10 out of 19 HealthShares ETFs had total net assets of less than $2.5 million, and certain funds, such as Dermatology and Wound Care (HRW) and European Medical Products and Devices (HHT), are trading fewer than 100 shares per day. Investors looking for long-term exposure to the health care space may want to steer clear of these funds, or at least understand the risk involved in buying such thinly traded and poorly capitalized ETFs. The fund closings earlier this year from Claymore Securities put investors on notice that market capitalization and trading volume can be as important as an innovative strategy when it comes to evaluating a fund.
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