Write a prescription for health care ETFs

Biotechnology, managed care and pharmaceuticals stocks have soared this year, helping some familiar and overlooked health care ETFs deliver stellar returns.

By Benzinga Sep 19, 2013 10:52AM

Prescription medicine expenses © Don Farrall/Photodisc/Getty ImagesBy Todd Shriber, The ETF Professor


With some help from the Federal Reserve, 2013 has been an excellent year for U.S., but some sectors have shined brighter than others.


And while it has been a good year for U.S. equities, the backdrop has been far from sanguine. Tapering and rising interest rates may be a thing of the past, at least for now, but those are just two of the issues have had to contend with this year.

Through it all, health care ETFs, broadly speaking, have proven resilient. "The sector, which represents about 13% of the S&P 1500 Index, has increased 28.3% in 2013 through September 13 versus the 18.8% gain for the S&P 1500 and is the best performing sector year to date," according to a new research note by S&P Capital IQ.


S&P Capital IQ notes that there are 10 sub-industries within the health care sector and nine are outpacing the broader market year-to-date. The "laggard" is health care equipment, which is up "just" 17.1% this year. As was previously highlighted, health care equipment names could be vulnerable to an oft-overlooked provision in Obamacare that introduced a new tax on medical device makers.


Even with that, the iShares U.S. Medical Devices ETF (IHI) is up almost 24% this year and touched a new 52-week high Wednesday.


Biotechnology, managed care and pharmaceuticals stocks have soared this year, helping some familiar and overlooked health care ETFs deliver stellar returns.


S&P Capital IQ has an Overweight rating on the Health Care Select Sector SPDR (XLV), the largest health care ETF by assets. With a 31.6% year-to-date gain, XLV is the best performer among the nine SPDR ETFs. The $7.6 billion fund's 56 holdings have a weighted average market value of $93.7 billion, indicating a heavy bias toward large-cap, blue-chip names.


That is exactly what investors get with XLV as Dow components Johnson & Johnson (JNJ), Pfizer (PFE) and Merck (MRK) combine for 29.5% of the ETF's weight. Those three stocks also represent the top-three holdings in the Vanguard Health Care (VHT), combining for 25.2% of that fund's weight.


VHT's 0.14% expense ratio is slightly below the 0.18% charged by XLV and enough to make the Vanguard offering the cheapest health care ETF on the market. VHT has returned 32.7% year-to-date and is also rated Overweight by S&P Capital IQ.


The pharmaceuticals sub-industry "has moved sideways over the past several months, following a sharp rise in the first half of the year that we see correlated to Treasury yields," said S&P Capital IQ. "When Treasury yields were lower at the beginning of the year, we believe income-focused investors were attracted to the 3-4% dividend yields offered by big pharmaceutical firms."


The iShares U.S. Healthcare ETF (IYH) also earned an Overweight rating from S&P Capital IQ. Like its rivals, IYH devotes a significant portion of its weight to J&J, Pfizer and Merck. Those stocks combine for 27.5% of IYH's weight, but also like its rivals, IYH features several biotech names among its top-10 lineup and that has helped lift the ETF to 32.4% gain this year.


Investors looking for some international sector exposure without a significant uptick in volatility may want to consider the iShares Global Healthcare ETF (IXJ). That ETF also garnered an Overweight rating from S&P Capital IQ and the research firm previously lauded the ETF for favorable risk characteristics.


J&J is IXJ's largest holding, but with a weight of just 7.8%. Novartis (NVS), GlaxoSmithKline (GSK) and Sanofi (SNY) are also found among IXJ's top-10 holdings. Foreign pharmaceuticals names offer investors a bit more yield as IXJ has a 30-day SEC yield that is more than 50 basis points higher than IYH, but that added yield does not mean added volatility. IXJ has three-year standard deviation of about 12% compared to 12.3% for IYH, according to iShares data.


For more on ETFs, click here.


Disclosure: Author is long J&J.


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