More than seven months into the year, investors may be running out of superlatives to lavish upon health care stocks and ETFs, but adulation is justified. Five of the 10 best-performing non-leveraged ETFs this year are health care-related plays and several of those funds were among the 10 best performers in July.
With August being a month that favors low beta sectors, health care ETFs could be a favored source of refuge for investors looking to stay in the market while coping with the summer doldrums.
"We attribute the recent strength to a number of factors, most notably a winding down the unprecedented wave of patent expirations sustained in 2012, a resurgence in new product launches and positive developments on the R&D front," said S&P Capital IQ in a new research note.
While patent expirations have been thought to be problematic for large-cap, blue-chip pharmaceuticals names, health care ETFs have weathered that storm with aplomb as biotechnology and small-cap names have benefited from a spate of new drug approvals.
"Last year also witnessed one of the strongest years in recent history with respect to new drug approvals. The FDA approved 39 New Molecular Entities (NMEs), or breakthrough innovative drugs, the highest number since 2003. We also believe the overall quality of the approved drugs improved from past years as well," said S&P Capital IQ in the note.
The Health Care Select Sect SPDR ETF (XLV and the iShares U.S. Healthcare ETF (NYSEARCA:IYH) are up an average of 30.3 percent year-to-date. XLV is the largest health care and second-cheapest with an expense ratio of 0.18 percent per year. Both XLV and IYH are heavy on blue-chip pharmaceuticals names as Dow components Johnson & Johnson (JNJ), Pfizer (NYSE:PFE) and Merck (NYSE:MRK) occupy the top three spots in both ETFs. That trio is 31 percent of XLV's weight and about 28.5 percent of IYH's weight.
"Pharmaceutical companies over the past five years have embarked on a number of strategies aimed at rejuvenating long-term growth. These strategies have included aggressive pricing, especially in specialty drugs; increased emphasis in expanding in rapidly growing emerging markets; and aggressive cost streamlining measures," said S&P Capital IQ.
Investors looking to to participate in further pharma upside have several options among ETFs that are more focused on pharma without exposure to biotech, medical devices and services.
The iShares U.S. Pharmaceuticals ETF (NYSEARCA:IHE) does feature some biotech names further down its 41-stock roster, but this fund is more a play on blue-chip pharma stocks with J&J, Pfizer and Merck combining for 27 percent of the fund's weight. Investors looking for a more adventurous approach should consider the SPDR S&P Pharmaceuticals ETF(NYSEARCA:XPH).
XPH's index has a median market cap of $4.55 billion, according to State Street data, indicating the ETF is not heavily focused on stocks like J&J and Pfizer. Allocations to stocks such as Questcor (QCOR) and Salix(NASDAQ:SLXP) have helped XPH gain nearly 39 percent this year. S&P Capital IQ rates both XPH and IHE Marketweight.
Also earning a Marketweight rating is the PowerShares Dynamic Pharmaceuticals Portfolio (NYSEARCA:PJP). PJP is not a market-cap weighted ETF and that is a good thing. The ETF's 30 holdings are evaluated on price momentum, earnings momentum, quality, management action, and value and there is nothing to complain about in terms of results as the fund is up nearly 26 percent this year.
PJP's underlying index, the Dynamic Pharmaceuticals Intellidex Index, has outperformed the S&P Pharmaceuticals Index this year, over the past year, three years and five years, according to PowerShares data.
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