Diversified Pharma ETFs Are the Way to Go

Michael Sivy writes a popular column in Money magazine, "Sivy on Stocks." I've enjoyed many of his "takes" on where to find stock market values over the years. However, I must express disappointment in Sivy's latest analysis of cheap sectors to own; specifically, Sivy prescribes owning the pharmaceutical giants through ownership of the Merrill Lynch Pharmaceutical HOLDR (PPH).

Sivy's assessment goes something like this: Leading drug stocks used to command premiums, while today, they are trading at bona fide discounts. This is because the drug makers do not currently have big blockbusters in the pipeline. Yet, thanks to the aging of the baby boomers, one should expect greater spending on prescription pharmaceuticals. Rather than predict the single standout company, says Sivy, "own a sector fund."

For the most part, the reasoning is sound. The problem arises when Sivy gives the nod to the Merrill Lynch Pharmaceutical HOLDR (PPH). In so doing, you may not be banking on a single company, but you're practically banking on the fortunes of just 3: Pfizer (PFE), Merck (MRK) and Johnson & Johnson (JNJ). These 3 stocks alone account for as much as 55% of the movement of PPH.

Don't get me wrong... I've owned PPH in the past. And I've helped my clients profit tremendously with the exposure to the largest 3 pharmaceutical companies.

However, I believe there may be better exchange-traded fund possibilities. For example, the iShares Global Healthcare Index (IXJ) offers a more diversified picture across the globe. If you are intrigued by drug makers like U.S.-based Merck and Pfizer, why wouldn't you be intrigued with global powerhouses like GlaxoSmithKline (GSK), Roche (RHHBY.PK) and Novartis (NVS)? U.S. and international companies provide greater diversification. And so far... better performance!

There's also the argument that mid-sized and smaller-sized companies will play an important role in drug creation and distribution in the future. It follows that the Powershares Dynamic Pharmaceutical Index (PJP) offers a more balanced approach to the sector/industry. With 30 large, medium-sized and small companies comprising this index, and no company accounting for more than 6.5% of index movement, PJP offers the diversification across market capitalization that the Merrill Lynch Pharmaceutical HOLDR (PPH) lacks.

I do believe that Sivy is "onto something." Yet it seems to me, if one want a balanced approach to pharmaceutical investing, one might want to diversify across company size and/or diversify across the globe.

Disclosure Statement: As a Registered Investment Advisor, Pacific Park Financial, Inc. may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[David Jackson:]

The interview with Jeffrey Feldman, founder of HealthShares, had a lot of discussion of these issues. He argued that growth will come from new treatments, so the mid-cap and small cap stocks are where you want to invest, not the large cap pharma stocks.

The interview is really worth reading if you haven't already seen it:
Interactive Q&A: Jeffrey L. Feldman, Creator of HealthShares and Founder and Chairman of XShares Group LLC

2007 May 17 03:47 PM

[Frank Li:]

Good article -- thank you.

The other problem with HOLDRs is that they're based on fixed baskets of stocks instead of indexes which are updated. So over time they become a less and less accurate representation of their industry.

2007 Jul 14 03:54 PM