FHLC: A Bet On American Demographics

| About: Fidelity MSCI (FHLC)

Summary

The number of senior citizens in the United States is likely to surge over the coming three decades due to the massive Baby Boomer generation reaching their golden years.

The number of obese people in the United States is also likely to surge over the same time period, causing an increase in health problems linked to obesity.

Both of these factors are almost certain to increase healthcare spending, which will benefit the companies in the industry.

FHLC is a very low cost way to bet on the American healthcare industry.

Like many indexed ETFs, the ETF is very concentrated at the top, which presents some risks.

I have been thinking a great deal lately about the demographic trends facing the United States over the coming years. In particular, the fact that the United States (along with the rest of the developed world) is faced with a graying population as the massive Baby Boomer generation begins to swell the ranks of the elderly. Accommodating this demographic shift will require policy adjustments, but here at this site we are most interested in investing. This line of thinking got me wondering about investing in healthcare as this is one good that people will necessarily require more of as they age. One of the easiest ways to invest in an entire industry is to purchase an exchange traded fund and fortunately there are several of them to choose from to make bets on the healthcare industry. For our purposes here, we will examine the Fidelity MSCI Health Care Index ETF (FHLC) for reasons that will be discussed later in this article.

Demographic Trends

It is unlikely to be a surprise to anyone reading this that the massive Baby Boomer generation is rapidly approaching their golden years. The Baby Boomer generation began immediately following World War II when returning soldiers began to enjoy the good economic environment in the nation and settled down to start families. That puts the start of the generation in 1946 and demographers generally put the end of it in 1964. These dates would make the oldest members of the generation 72 years old today - well beyond the normal retirement age. The youngest Baby Boomers turn 54 later this year so they still have about ten years to go until retirement. As we can also see, in ten years the oldest members of the generation will be in their early 80s, which tends to be the point at which they begin to consume increasing quantities of healthcare services.

There were approximately 77 million babies born during the Baby Boomer era, although various causes have reduced their numbers to approximately 74 million, or roughly 20% of the U.S. population, today. The next three decades will see all of these people entering into the twilight years of their lives, which will quite clearly boost the demand for medical treatment as the natural deterioration of their bodies starts to affect them. This is one of the reasons why the Medicare system is expected to become insolvent in eight years.

A second demographic trend that is affecting the nation is one that I have written about several times over the past few months. That trend is the surging obesity rate in the United States being brought about by the lifestyle changes that technological development has brought about. As I discussed in a recent article, the obesity rate in the United States is expected to climb from 39% today to 55% in 2045, which is also the same time period that will see all of the Baby Boomers celebrate their eightieth birthday. Obesity brings with it several health problems including a heightened risk of heart disease, high blood pressure, diabetes, hypertension, and osteoarthritis, among others. The increased prevalence of these conditions in the obese population is one reason why their aggregate health care costs are higher than individuals of a healthy weight. We can conclude therefore that the nation's total health care costs will increase as a growing proportion of the population becomes obese.

The Investment

We have therefore established that the demand for healthcare will increase dramatically in the United States over the next three decades. Barring some sort of a massive shift in the healthcare system that seems highly unlikely, this growing demand for services will boost the amount of money that the nation spends on healthcare, which will boost the fortunes of the companies active in the space. This would seem to be a sound investment thesis. Now let us determine if the Fidelity MSCI Health Care Index ETF is a good way to invest in this trend.

As the name implies, the ETF is designed to track the MSCI USA IMI Health Care Index. This is a market cap-weighted index consisting of 334 large- and mid-cap stocks in the healthcare industry. As is often the case with market cap-weighted indices, a handful of large companies dominate the index. Here are the top ten constituents of the index:

Source: MSCI

As we can see, the top ten largest companies alone make up approximately 42.80% of the entire index. We see a similar structure in the fund:

Source: Fidelity Investments

Here we see that the top ten holdings comprise 42.15% of the ETF and interestingly Thermo Fisher Scientific (TMO) has been swapped for Bristol Meyers Squibb (BMY). The differences could simply be caused by different publication dates of the two documents and share price fluctuations however so it is likely not worth worrying about. What is important to keep in mind however is that the fortunes of these ten companies will have an outsized impact on the performance of the ETF due to their concentration in the fund.

Fortunately, we do see that the index is quite well diversified across the various sub-sectors of the healthcare industry.

Source: MSCI

Admittedly, since a sizable portion of the aging Baby Boomers will likely be covered by Medicare, I would prefer not to see any managed health care companies such as UnitedHealth (UNH) in a pureplay portfolio to bet on that demographic. It is certainly possible however that those companies would profit off of a rising obesity rate. They only account for approximately 12.66% of the portfolio though so their presence may not be a big deal for some. If one wanted to artificially remove these firms from the portfolio, one could simply short UnitedHealth Group as part of a pair trade. The majority of the portfolio consists of pharmaceuticals, biotechnology, and health care equipment, which is acceptable for the thesis that we are attempting to play.

Why FHLC?

At this point, an investor may be wondering why they should pick FHLC instead of a similar ETF such as the iShares U.S. Healthcare ETF (IYH) or the Vanguard Health Care ETF (VHT). The simple reason is one of expenses - the Fidelity ETF has the lowest expense ratio out of the three options. This can be clearly seen here:

ETF Name Ticker Symbol Expense Ratio
iShares U.S. Healthcare ETF IYH 0.44%
Vanguard Heath Care ETF VHT 0.10%
Fidelity MSCI Health Care ETF FHLC 0.084%

The expense ratio is a recurring fee that the fund sponsor takes in order to maintain the fund. A lower expense ratio therefore means that the fund sponsor takes a smaller portion of the fund's assets, thus leaving more for the investors. Therefore, more of the returns flow through to the investors of the fund. All else being equal then, the ETF with the lowest expense ratio should have higher returns. This is indeed what we see, although the Vanguard ETF does beat the Fidelity one on some days and vice versa. Both consistently outperform the iShares offering.

Source: Fidelity Investments

Thus, there appears to be no reason at all for an investor to choose the iShares ETF to play the demographic thesis. Either FHLC or VHT appear to be equally good choices.

Risks

In this case, our investment thesis seems to be a relatively low risk one since there is nothing that can be done to prevent the fact that the population of senior citizens in the United States will grow dramatically in the coming years. A huge change in the financing system of healthcare in the United States could have an impact on some of the firms in the ETF but it is hard to see how that would change the fact that pharmaceutical firms will almost certainly sell more drugs and equipment manufacturers will sell more equipment. That is however the biggest risk facing this thesis.

Conclusion

In conclusion, the demographics of the United States make it virtually certain that healthcare spending will increase dramatically over the coming decades, which should prove to be a net positive for the companies in the industry. An easy way to play this trend is to invest in a healthcare-focused ETF of which FHLC appears to be a good one. However, as with most indexed ETFs, it does have strong concentration at the top so the fortunes of a handful of companies could have an outsized effect on the fund as a whole.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.