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Summary

  • The health care sector has significantly outperformed the market over the last 1, 3, and 5-year time frames.
  • Specific industry groups such as pharmaceuticals and biotechnology can often provide a measured boost of additional alpha.
  • The following article hones in on the three best health care ETFs so far this year.

As a sector, health care has a lot to offer in terms of fundamental and technical data that supports ongoing innovation and profitability. The aging baby boomer population combined with an increased focus on adorable health insurance is continuing to promote a focus on new drugs and medical devices aimed to increase quality of life.

From a performance standpoint, the Healthcare Select Sector SPDR (NYXLV) has significantly and consistently beaten the SPDR S&P 500 ETF (NYSPY) over multiple time frames. The following table illustrates the differences in average annual return of both funds over the last 1, 3, and 5-years.

Ticker

1 Year

3 Year

5 Year

XLV

29.89%

21.89%

20.44%

SPY

24.56%

16.39%

18.63%

*Data as of 6/30/14 Source: www.spdrs.com

The current list of health care-related ETFs (excluding leverage) now stands at 25. While XLV works well as a large-cap benchmark for the health care sector, there are a number of ETFs that track a more sophisticated group of companies. These can include: industry groups, small companies, fundamental indexes, international stocks, and a host of other categories.

Often times these unique ETFs can produce much superior returns when compared to a plain-vanilla index. Being in the right spot at the right time, such as iShares NASDAQ Biotechnology ETF (NASDAQ:IBB) return of 65.51% in 2013, can lead to a tremendous advantage in your portfolio.

The following funds represent areas that have had the strongest performance of the health care group in 2014. Some of which you may never have heard of before.

Pharmaceuticals

The Market Vectors Pharmaceutical ETF (NYPPH) is the best performing health care industry ETF with a total return of 18.29% this year. This fund invests in the 25 largest and most liquid U.S.-listed pharmaceutical companies based on market cap and trading volume. PPH charges a net expense ratio of 0.35% and has a 30-day SEC yield of 1.84%.

While 58% of the holdings in PPH are U.S.-based, a healthy exposure to stocks in Switzerland, the United Kingdom, and France has helped propel it past its peers this year. Investors in this ETF have benefitted from large jumps in Allergan (NYSE:AGN) and Novo Nordisk (NYSE:NVO), which have gained 53% and 26% respectively.

The continued development and distribution of new drugs makes the pharmaceutical industry a bright spot in the health care industry for the foreseeable future.

Biotechnology

While biotechnology stocks have cooled off significantly from their run last year, one ETF has continued to put up impressive results. The First Trust NYSE Arca Biotechnology Index Fund (NYFBT) has over $1.2 billion invested in just 20 biotechnology companies with an equal-weighted portfolio structure.

This concentrated basket of stocks allows for each holding to contribute a proportionate share of the total performance, which has combined to generate positive returns of 17.71% this year. The stocks in FBT are rebalanced on a quarterly basis to ensure the weightings remain in line with the index specifications and the fund charges an expense ratio of 0.60%.

This focused exposure can also work against the concept of diversification that ETFs have become so famous for as well. An ETF with fewer holdings can be subject to additional volatility if one stock fails to perform with the group. However, for the time being the FBT portfolio appears to be firing on all cylinders.

Healthcare Providers

The iShares U.S. Healthcare Providers ETF (NYIHF) is another leading segment of the healthcare sector this year as well. IHF has gained 13.57% so far in 2014 and just recently hit a new all-time high. This ETF tracks 49 stocks engaged in health insurance, diagnostics, and specialized treatment.

Companies in IHF such as UnitedHealth Group (NYSE:UNH) and WellPoint Inc (WLP) have continued to benefit from the halo effect of Obamacare along with a growing need for medical services here in the United States. IHF charges a modest 0.43% expense ratio and has over $500 million in total assets.

Historically, this fund has had less volatility than the market as a whole. According to the iShares website, IHF has a beta to the S&P 500 Index of just 0.65, which indicates smaller price fluctuations than a broad measure of stocks.

The Bottom Line

When you are researching which sector or ETF to purchase, make sure you pay close attention to the construction of the underlying index. That will have a significant impact on the performance of the fund through good times and bad. You should also note the expense ratio of the fund, as many ETFs have complementary portfolios with vast differences in annual fees.

In addition, it pays to know where the aggressive and conservative areas of each sector lie. In the case of healthcare, biotechnology is going to be characterized as a high beta industry, while healthcare providers will generally be lower in overall volatility.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

Source: This Year's Hottest Healthcare ETFs