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By Matthew Hougan

Let me be clear: I was not arguing in my last blog that the Benjamin Graham ETN is the best total market ETF/ETN on the market today.

Far from it. As I've written before, celebrity branding makes me very nervous. The Ben Graham ETN is not a true total market fund. It takes huge risks and bets against a true market portfolio, with a non-transparent methodology that any investor would question.

But the Ben Graham ETN is almost beside the point. The point is that ETFs give investors the means to express their precise views on the market.

My point would have better been made by examining all the ETFs in a given sector. Take, for example, the returns of the various healthcare ETFs in January.

Healthcare ETFs Sorted By January Returns

Fund Name

Ticker

ER

Assets

YTD

2008

Mkt Cap

P/E

iShares DJ US Medical Devices

IHI

0.48

247.8

3.40

-36.79

4,312

16.2

First Trust Healthcare Alphadex

FXH

0.70

12.5

2.38

-29.50

7,169

13.0

PowerShares Bio and Genomics

PBE

0.63

157.2

0.44

-26.75

2,388

17.5

Rydex S&P EqualWgt HealthCare

RYH

0.20

35.1

0.06

-26.50

10,766

12.8

iShares Health Providers

IHF

0.48

87.5

-0.39

-43.46

5,897

10.4

iShares NASD Biotech

IBB

0.48

1452.6

-0.45

-12.28

5,851

21.1

Healthcare Select Sector SPDR

XLV

0.21

1906.4

-1.21

-23.31

40,461

14.1

SPDR Biotech

XBI

0.35

493.3

-1.59

-8.63

4,124

27.3

iShares DJ Health Care

IYH

0.48

861.2

-1.62

-22.90

32,979

14.6

Vanguard Health Care

VHT

0.25

562.5

-1.71

-23.32

27,596

17.3

First Trust AMEX Biotech

FBT

0.60

57.9

-1.93

-18.24

4,062

21.7

PowerShares Dynamic Health

PTH

0.71

72.5

-2.55

-34.83

2,967

12.9

SPDR Pharmaceuticals

XPH

0.35

48.4

-2.82

-9.02

6,478

11.2

iShares DJ Pharmaceuticals

IHE

0.48

117.8

-3.29

-14.92

12,321

13.1

PowerShares Dyn Health Services

PTJ

0.70

16.3

-3.44

-42.99

4,489

10.4

PShares FTSE RAFI Health

PRFH

0.75

11.5

-4.25

-24.41

43,772

13.4

PowerShares Pharma

PJP

0.63

138.2

-4.84

-10.86

10,861

14.5

The swing on YTD results is 8.24%, ranging from the iShares DJ US Medical Devices ETF (NYSEARCA:IHI), which was up 3.40%, to the PowerShares Pharma ETF (NYSEARCA:PJP), which was down 4.84%.

If you look at the gradation of returns by industry segment, you can break it down more or less into industry categories:

  • Medical Devices
  • Biotech
  • Broad-based Healthcare
  • Pharmaceuticals
  • Healthcare Services

I'm Monday morning quarterbacking here, but as a former biotech analyst, it's easy to explain these returns.

If you examine which parts of the healthcare sector are most exposed to both the current economic downturn and general cost pressures, it would break out the same. Both biotech drugs and medical devices are cost-insensitive: they are generally fixed-price products with limited or no generic competition, and somewhat limited replacement alternatives within their space (particularly on the biotech side). Pharmaceuticals, on the other, are facing enormous generic competition with the ramp-up of programs like the $4 generics Wal-Mart (NYSE:WMT) plan. Health care services, to round out the group, is more exposed to employment trends and broader cost-cutting measures at the corporate level.

That's not to say that these returns will follow a similar pattern in the future. But you could make an argument for one or another piece of the healthcare sector depending on your view of the economy.

Even once you make a sector or industry choice, how you drill down into individual funds makes an enormous difference. Biotech ETFs, for instance, had returns in January ranging from 0.44% to -1.93%. The reason is that various biotech ETFs tackle different parts of the market: some focus on large established biopharmaceutical companies, and others focus on smaller, more nimble genomics plays.

The point is that investors have important choices to make with ETFs. They can buy full market exposure with a few funds and be done with it. They can make broad size/style tilts and be satisfied. Or they can drill down to very specific industries and make specific allocations. Even within each of those levels, they can make specific ETF choices that have a major impact on returns.

About The Ben Graham ETNs

As an aside, let me answer the question Jim posed in his last blog about why the Ben Graham ETN is structured as an ETN. The first and primary reason is that it is an actively managed product. There may be some quantitative metric behind it, but it is as active as it wants to be. Since you can't run an actively managed ETF very easily right now, putting it in an ETN wrapper was the only solution for getting it launched.

The next logical question might be: why would an investor buy an actively managed equity ETN and take on the related counterparty risk, when they could just buy an actively managed mutual fund? It's a good question, and I'm not sure an investor should.

But ETNs do have a major advantage for taxable investors, which is that it should not pay out any capital gains distributions. Cap gains distributions cost actively managed funds 1-2% per year. Is a 1-2% increase in after-tax returns each year worth the counterparty risk that accompanies an ETN? Maybe, maybe not: but it's a legitimate calculus to consider.

Source: Finding the Right ETF