Health Care Funds To Avoid

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Includes: FHLC, IHE, IHF, IHI, VHT, XPH
by: Strubel Investment Management
Summary

Recent comments by UnitedHealthcare highlighted the risk of health care reform.

The US spends almost twice as much on health care as the average developed nation, leading to voter anger.

Certain health care sub-sectors are likely more vulnerable to reform then others.

Since last Tuesday, when UnitedHealthcare (UNH)’s discussion of Medicare-for-All spooked investors, health care stocks have dropped 5%, while the market was almost flat over the same time period.

In our opinion, there is a good reason for healthcare investors to be fearful. We will go over why and what health care funds might be hit the hardest.

US Healthcare is Expensive

It’s no secret that health care in the US is very expensive. Indeed, the US spends about twice as much on a per capita basis on health care as other developed nations. In addition, there is no real evidence that health outcomes in the US are any better than other countries (and if they are, they certainly are not twice as good). In fact, one source even shows US health care quality at near the bottom when compared to other developed nations.

(Graphic source: Alliance Bernstein)

Everyone seems to have their own opinion about the quality of care in the US, so I’ll leave it to you, the reader, to decide where the US should be ranked. The point is, many in the US feel they are not getting what they pay for when it comes to health care.

Now, add to this that the number one cause of bankruptcies in the US is medical expenses (and a majority of those filing had health insurance) and you can see why voters have consistently cited health care and health care costs as one of their top issues.

While a huge wholesale change to the US health care system might not be likely, especially if the Republicans keep the Senate and Presidency in 2020, there could be minor changes. There is risk even if some type of universal health care plan or system isn’t enacted. Even small changes such as allowing Medicare to negotiate drug prices or changes to the ACA to rein in plan costs could cause profits in the health care sector to grow slower (or even fall). Incrementalism is as much a risk as a wholesale change to the US health care system.

It’s also likely that voters will continue to clamor for changes to the health care system until costs and quality are brought more in line. Even if the health care sector survives the 2020 election, it’s still important to remember we have elections every two years that can lead to major political changes

So, let’s look at which types of health care stocks and funds might be most affected by efforts to control costs.

Ugly

The stocks that are likely to be the hardest from any health care changes are the ones where there is the most fat to cut. Administrative expenses account for some of the greatest disparity in health care costs between the US and other developed nations. Administrative spending in the US is two and a half to eight times greater than other countries! The biggest impact is likely to be felt by insurance companies and, perhaps to a lesser extent, health care service providers.

In this case, the iShares U.S. Healthcare Providers ETF (IHF) might be hit the hardest. Over half of the ETF (and the index it tracks) is made up of managed health care (e.g., health insurance) stocks. Another 31% of the index is health care services stocks like hospitals and dialysis providers. That means about 80% of the fund is invested in the stocks that are highly likely to experience the biggest impact.

The Bad

It’s no secret that the US pays more for pharmaceuticals than other developed countries. Estimates range from two to six times more than other developed countries. Any type of health care reform effort is likely to focus on drug prices.

This makes ETFs that focus on pharmaceutical companies particularly vulnerable. Funds like the iShares U.S. Pharmaceuticals ETF (IHE) or the SPDR S&P Pharmaceuticals ETF (XPH) are basically fully invested in companies vulnerable to efforts to lower drug prices. The only saving grace for these ETFs (if you fear health care reform) is that they contain several companies focused on animal health, and many pharmaceutical companies have substantial international businesses which would be unaffected by health care changes in the US.

The Good (If you want to call them that)

The funds likely to fare the best if some type of health care reform is enacted are diversified health care sector funds, such as the Vanguard Health Care ETF (VHT) or the Fidelity MSCI Health Care Index ETF (FHLC). Another intriguing idea is focusing on health care companies whose sales growth is tied to the trend of an aging population. Companies may be able to offset the negative effects of lower margins via higher sales growth. Medical equipment companies and ETFs that track them, such as the iShares U.S. Medical Devices ETF (IHI), are likely worth a closer look in this regard.

Summary

So long as health care costs in the US remain high and serve as the number one driver of personal bankruptcy, voters are likely to keep sending candidates to Washington who promise to change the current system. So long as this dynamic exists, the health care sector will always be a year or two away from significant political risk (major Federal elections occur every two years). Overweighting the health care sector seems risky, and some sub-sector specific funds seem like they could fare even worse, especially if there is significant reform.

Disclosure: I am/we are long FHLC,VHT. 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.