Investors get a bad rap for buying and selling at the worst possible times, and that seems to be the case with health-care funds.
After years of outperformance, they fell 10.6% in 2016, sending many investors to the exits. Non-institutional share classes suffered a record $18 billion in net outflows last year, according to Morningstar. That trend continued into this year, with $2 billion in net outflows in January. The previous record, set in 2006, was $5.2 billion in outflows.
Since then, performance by health-care stocks has come roaring back. On average, the roughly three dozen distinct portfolios tracked by Morningstar are up 11.75% in 2017, through March 6.
That's nearly double the return of the Standard & Poor's 500 index (.SPX). The long-term results also say something. On average, these funds are up 17.8% annually over the past five years and 11.3% per annum over the past decade.
"This is just another example of people shying away from what I think is the single best sector you can invest in," says Daniel P. Wiener, a financial advisor and editor of The Independent Adviser for Vanguard Investors. He recommends overweighting the sector with an overall allocation of 20% to 25%, which he says is in line with health care's growing slice of the economy; it was recently nearly 18% of U.S. gross domestic product, and could increase to 28% over the next quarter-century.
Health care is benefiting from a growing global middle class, as well as an aging population bent on cheating time. "Unlike prior generations, the boomers are not going out sitting on the porch, rocking away," says Wiener, who turned 61 last week and is just back from his annual helicopter skiing trip.
Last year's tough showing for health care was due to a combination of factors. "Parts of the market had gotten expensive," says Eddie Yoon, manager of the $6.6 billion Fidelity Select Health Care fund (FSPHX) since 2008. While a reset seemed necessary, much of the sector's suffering came from conjecture. "In [the third quarter] of 2015, there was the infamous Hilary Clinton tweet on drug prices," followed by a year of presidential campaigning with health care at the center of the debate, adds Yoon.
That was enough to send relative valuations for the sector near 40-year lows. After trimming his biotechnology holdings in late 2015, Yoon says he was able to "take advantage of a lot of fear in the market" and bump up his biotech exposure.
Meanwhile, a sibling fund, $9.6 billion Fidelity Select Biotechnology (FBIOX), has climbed 17.9% this year, and an average of 15.9% annually over the past decade.
Health care will have more than its share of headline risk for the foreseeable future, as the debate over replacing the Affordable Care Act gains momentum. But this doesn't change the secular drivers, adds Yoon, whose fund is up an average of 20% a year over the past five years.
A closer look at biotech stocks
Fidelity's diversified sector fund is the industry's oldest, but the largest is $46.2 billion Vanguard Health Care (VGHCX), managed by a team at subadvisor Wellington Management; it has risen by a yearly average of 10.6% over the past 15 years. The same team also runs the $1.4 billion Hartford Healthcare fund (HGHAX), which is up 10.2% annually, on average, over the past 15 years.
While many of the same names are among the two funds' top holdings, the Hartford fund tilts smaller, with an average market cap of $20 billion, less than half the Vanguard fund's. This probably reflects the Hartford fund's smaller asset base, says Wiener, who speaks highly of both funds. The Hartford fund carries higher fees than its Vanguard counterpart.
Rounding out the list of health-care heavy hitters is $10.9 billion T. Rowe Price Health Sciences (PRHSX). It had a manager change in April 2016—its second since longtime chief Kris Jenner left in 2013 to start a hedge fund. It's still too early to say whether new skipper Ziad Bakri can carry on the fund's 10-year average annual returns of 15.7%. But his first year was heartening; the fund's 12-month performance is middle of the pack, but it still is up 12.3% in 2017.
There are many ways for investors to access health care, through diversified mutual funds and exchange-traded funds, but there is something to be said for owning an actively managed, health-care fund. A manager or team of managers can navigate the many nuances of this wide-ranging sector. "You've got the research companies, the pharmaceuticals, devices, and then there's the service side of the business with hospitals and HMOs. And its global," says Wiener, who prescribes a 5% to 10% allocation to a dedicated health-care fund.