Healthcare is one of the major sector categories as defined by the Global Industry Classification Standard (GICS), along with other top-level sectors such as information technology, telecom, energy, financials and others. GICS then breaks down the healthcare sector into two major Industry Groups: (1) Healthcare equipment and services, and (2) pharmaceuticals, btechnology and life sciences.
The ETF industry provides many ETFs in the healthcare sector. We will first cover broad U.S. and global healthcare ETFs. We will then move on to the more narrowly-defined ETF categories of pharmaceuticals, healthcare providers, medical devices and biotechnology.
U.S. Broad Healthcare ETFs
Our Best in Class choice for the broad U.S. Healthcare ETF group – Our pick for the broad U.S. healthcare ETF group is the Vanguard Healthcare ETF (VHT) mainly because of its better return performance on both the monthly and weekly charts relative to its two main competitors, the Healthcare Select Sector SPDR Fund (XLV) and iShares Dow Jones US Healthcare Sector Index Fund (IYH). While SPDR’s XLV has the largest amount of assets under management in the group by far at $3.8 billion, Vanguard’s VHT still has a substantial amount of assets at $660 million, which gives it plenty of liquidity and narrow bid-offer spreads. On the negative side, Vanguard’s VHT has an expense ratio of 0.24% that is slightly higher than 0.20% for SPDR’s XLV, but we believe the higher returns that have been produced by Vanguard’s VHT more than offset the slightly higher expense fee. We also like Vanguard’s VHT because it is more diversified in holding 294 stocks, versus only 52 stocks held by SPDR’s XLV. That means that XLV has a higher weight on the big stocks in the sector and thus has more single-company risk than the more diversified Vanguard VHT, which is a negative factor for XLV.
Global Healthcare ETFs
Our Best in Class choice for a global Healthcare ETF -- The iShares S&P Global Healthcare Sector Index Fund (IXJ) is the only substantive ETF in the global segment since the other two ETFs, SPDR’s IRY and iShares AXHE, have minimal assets under management and their longevity is therefore in question. iShares IXJ is therefore our Best in Class choice for the global healthcare sector. We like the exposure to all the world’s major healthcare companies that iShares iXJ provides since healthcare is clearly a global industry where there are many major players that have their stocks listed outside the U.S. However, we must note that iShares IXJ has underperformed our U.S. healthcare pick, Vanguard’s VHT, on both the monthly and the weekly charts. Nevertheless, we are still choosing iShares’ IXJ as our overall pick for the broad healthcare category due to the fact that we believe exposure to all of the world’s major health care companies trumps the difference in historical performance.
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Narrower U.S. Healthcare Segments
Now that we have discussed ETFs in the broad healthcare sector, we turn to narrower segments of the healthcare industry including healthcare providers, pharmaceuticals, medical devices and biotechnology. The healthcare provider segment focuses on companies that primarily provide healthcare insurance coverage for patients, companies like UnitedHealth Group (UNH) and Wellpoint Health Networks (WLP).
The medical device segment focuses on companies that provide physical products, other than medicines, that are used in healthcare for diagnosis, prevention, monitoring or treatments of humans. The Medical Device category includes a wide variety of products from tongue depressors to X-ray machines, stents, and artificial hip implants. This group includes companies such as Medtronic (MDT) and Covidien (COV).
The pharmaceuticals segment focuses on companies engaged in the research, development or production of pharmaceuticals, i.e., drugs and medicines that act through biochemical processes for medical treatment. This group includes companies such as Bristol-Myers Squibb (BMY) and Eli Lilly (LLY).
The biotechnology segment focuses on companies that are “primarily engaged in the research, development, manufacturing and/or marketing of products based on genetic analysis and genetic engineering, including companies specializing in protein-based therapeutics to treat human diseases,” according to the GICS classification system. The key difference between biotech and regular drugs is that medical biotech typically involves the gene-based manipulation of living cells or organisms to produce treatment, prevention or therapy for humans. This group includes companies such as Amgen (AMGN) and Pharmasset (VRUS).
U.S. Health Care Provider ETFs
iShares Dow Jones US Health Care Providers Index Fund (IHF) – This fund, launched in May 2006, has $210 million in assets under management. The fund has an expense fee of 0.47%. The fund tracks the Dow Jones U.S. Select Healthcare Providers Index. The fund holds 49 U.S.-listed stocks. The five top holdings are: United Health Group (15.3%), Wellpoint (9.5%), Express Scripts (8.7%), Medco Health Solutions (7.6%) and Aetna (5.9%). We would recommend this fund for investors who are specifically looking for exposure to the narrower segment of healthcare providers since this fund has sufficient size to assure liquidity and longevity and since its fee is reasonable.
U.S. Medical Devices ETFs
iShares Dow Jones US Medical Devices Index Fund (IHI) – This fund, launched in May 2006, has $360 million in assets under management. The fund has an expense fee of 0.47%. The fund tracks the Dow Jones U.S. Select Medical Equipment Index. The fund holds 40 U.S.-listed stocks. The five top holdings are: Medtronic (12.7%), Covidien (8.9%), Thermo Fisher (7.6%), Intuitive Surgical (6.9%) and St Jude Medical (6.2%). We would recommend this fund for investors who are specifically looking for exposure to the narrower segment of medical devices since this fund has sufficient size to assure liquidity and longevity and since its fee is reasonable.
U.S. Pharmaceuticals ETFs
Our Best in Class ETF choice in the pharmaceuticals group – There are three ETFs in the pharmaceuticals group, all with fairly similar sizes in terms of assets under management. Yet each ETF presents a very different type of exposure to the sector. The SPDR S&P Pharmaceuticals ETF (XPH) is the largest ETF in the sector by a modest margin and provides equal-weighted exposure to the sector. The iShares Dow Jones US Pharmaceuticals Index Fund (IHE) provides traditional market-cap weighted exposure to the sector with a heavier weight on the large-cap stocks in the sector such as Johnson & Johnson (JNJ) and Pfizer (PFE). PowerShares Dynamic Pharmaceuticals Portfolio (PJP) uses an active selection method and equal-weighting in order to try to beat a passive index.
Based purely on performance, PowerShares’ PJP is the winner taking into account the monthly chart and the weekly chart. However, PowerShares’ PJP is the smallest ETF in the sector and has the highest expense fee of 0.63%. Also, the return of the ETF is based on the Intellidex selection methodology, which may or may not work in the future.
For investors who are more comfortable with a traditional passive index, the choice comes down to the equal-weighted SPDR XPH or the market-cap weighted iShares IHE. For our money, we would choose the SPDR XPH because it outperforms iShares IHE on both the monthly and weekly charts and has a lower expense fee of 0.35% versus 0.47%. Also we like the equal-weight methodology of the SPDR XPH because it gives an equal weight to small- as well as large-cap pharmaceutical companies, delivering more exposure to smaller pharmaceutical companies that are traditionally the proving grounds for many new drug treatments.
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Our Best in Class choice in the U.S. Biotech ETF group – Our pick in this group is the SPDR S&P Biotech ETF (XBI). SPDR XBI has $450 million in assets, which is well below $1.4 billion for iShares Nasdaq Biotechnology Index Fund (IBB), but is still more than enough to assure good liquidity and narrow bid-offer spreads. We are choosing SPDR XBI because its performance is currently better than iShares IBB on both the monthly and weekly charts. First Trust’s FBT has good performance on the monthly chart, but it has not performed well on the weekly chart and we do not like the fact that it holds only 20 stocks, which is an unusually small number for an ETF and therefore means that there is relatively high single-company risk.
We also like SPDR XBI because it has the lowest expense fee in the group of 0.35% and because of its equal-weighting methodology, compared with the market-cap weighting for iShares IBB. The equal-weighting methodology means that SPDR XBI gives as much weight to small-cap biotech firms as it does to large-cap firms. There are often more exciting new product developments at smaller-cap firms compared with the large, more risk-averse firms.
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