The healthcare sector is off to a decent start in 2020 with the S&P 500 Health Care Index higher by 2%, indicating some market participants are embracing the group’s defensive and well-valued characteristics.
On the other hand, with 2020 being a presidential election year, challenges linger for health stocks. On a historical basis, returns for the sector are better in non-election years and related risks — including Medicare For All and lower drug prices — could be amplified the longer it takes for Democrats to choose a nominee and if that candidate is viewed as a credible challenger to President Trump.
Political risks aside, there are reasons to consider healthcare stocks this year: some offer dividend growth and defensive positioning, while others are levered to themes of investors’ thirst for growth and the Food and Drug Administration’s (FDA) expedited approach to new treatment approvals.
And for investors that simply don’t want to stock pick in the healthcare space, there are plenty of solid exchange traded funds for access to the sector. Here are a few to consider.
Health Care Select Sector SPDR
Expense ratio: 0.13% per year, or $13 on a $10,000 investment.
The Health Care Select Sector SPDR (XLV) is the largest ETF dedicated to healthcare stocks. XLV provides exposure to “pharmaceuticals; health care equipment and supplies; health care providers and services; biotechnology; life sciences tools and services; and health care technology industries,” according to its issuer.
That broad approach gives XLV exposure to most of the aforementioned trend factors for the sector, both positive (growth in more exciting healthcare segments) and negative (political headwinds). However, investors may not want to be hasty in dismissing XLV simply because the campaign trail is heating up.
“Health care firms are expected to post the strongest earnings and revenue growth in 2019 of any sector, and over the past three months, analysts have been ratcheting up their 2020 earnings-per-share (EPS) estimates for the sector,” according to State Street.
Only technology is expected to post better earnings growth than healthcare this year, but the latter is discounted relative to historical averages.
iShares U.S. Healthcare Providers ETF
Expense ratio: 0.43%
The iShares U.S. Healthcare Providers ETF (IHF) is one of the epicenters of political risk pertaining to healthcare stocks because this fund provides access to managed care providers, the very companies expected to languish if Medicare For All comes to pass. That includes Dow component UnitedHealth Group (UNH), which accounts for almost 23% of IHF’s roster.
UnitedHealth Group CEO David Wichmann, who interestingly rarely discusses politics in relation to the company’s performance, said last year nationalized healthcare would disrupt healthcare and markets did not take that to mean the positive kind of disruption.
The bottom line with IHF this year is that regardless of an investor’s political leanings, that investor is making a political bet with this fund. The bet is a winner if President Trump is reelected or a Democrat that doesn’t favor Medicare For All wins. An “MFA” supporter taking the White House would present near-term headwinds to UNH, CVS Health (CVS) and other big-name IHF holdings.
KraneShares MSCI All China Health Care Index ETF
Expense ratio: 0.65%
The new coronavirus has sent most China ETFs sliding in recent weeks, but among the positive standouts is the KraneShares MSCI All China Health Care Index ETF (KURE). As of February 14, KURE was sporting a one-month gain of 5.12%, a period including reports of the first documented coronavirus cases. Over the same period, the MSCI China Index was lower by almost 3%.
Given the recent ebullience surrounding KURE, the primary near-term risk for the fund could be a resolution to the coronavirus issue. However, should those headlines emerge, it would likely spark a rally in Chinese assets, taking KURE along for the ride.
Beyond near-term headlines, there are compelling reasons to consider Chinese healthcare stocks via KURE for longer holding periods, including growth and China’s status as just now maturing healthcare market.
“China is the second largest healthcare market globally with total healthcare expenditure reaching $558 billion in 2016, a number projected to reach $1.1 trillion by 2020,” according to KraneShares.
Invesco S&P SmallCap Health Care ETF
Expense ratio: 0.29%
The Invesco S&P SmallCap Health Care ETF (PSCH) is higher by almost 6.2% to start 2020, more than triple the returns of some basic large-cap healthcare funds. One of the catalysts PSCH has is that small-cap healthcare stocks are less sensitive to politics than their large-cap peers.
“Small-cap health care has been the place to be so far in 2020 and will likely remain so,” said Nicholas Colas, co-founder of DataTrek Research, in a recent note. “First, they are less likely to be in the crosshairs of any Presidential political debate. Second, they are more likely to be ‘Growth’ stocks rather than ‘Value.’”
Indeed, PSCH is mostly a growth fund. More than 63% of its 72 holdings are classified as growth, nearly eight times the weight allocated to value fare. That’s another tailwind at a time when growth continues to trounce value. PSCH currently resides just half a percent below all-time highs.
ARK Genomic Revolution ETF
Expense ratio: 0.75%
When it comes to the broader healthcare stocks universe, one of the hottest places to be is genomics, but picking stocks here can be tricky. The actively managed ARK Genomic Revolution ETF (ARKG) can reduce genomics guesswork for investors. There’s an array of compelling corners of the genomics market, including DNA sequencing, that bode well for ARKG’s long-term trajectory.
“Next-generation DNA sequencing (‘NGS’) is the driving force behind the genomic revolution. Since 2003 the cost to sequence a human genome has dropped from nearly $3 billion to less than $1,000,” said ARK Invest in a recent note. “ARK believes that as costs continue to drop, NGS will become a standard of care in oncology. It will introduce more science into healthcare decision-making, enable personalized medicine, and accelerate drug discovery.”
Other fast-growing segments accessible via ARKG include bioinformatics, CRISPR, stem cell technologies and targeted theraputics.
Past performance doesn’t guarantee future returns, but over the past three years, ARKG is beating the largest biotechnology ETF by margin of better than 3-to-1.
ALPS Medical Breakthroughs ETF
Expense ratio: 0.50%
The ALPS Medical Breakthroughs ETF (SBIO) is another fund that efficiently addresses a compelling, but hard-to-navigate area: smaller healthcare stocks with drugs or treatments in clinical trials.
History shows that mid- and small-cap biotechnology companies can deliver significant upside when they deliver positive FDA trial news. Likewise, if the news is bad, those stocks typically plunge, forcing investors to assess the company’s cash position.
No fund can completely eliminate those risks, but SBIO mandates that member firms have enough cash to survive at least 24 months at current burn rates.
Another perk of SBIO is that its combination of companies with somewhat decent balance sheets, drugs in Phase II or III trials and a component market value capped at $5 billion is that those traits make SBIO holdings attractive as takeover targets to larger companies.
SPDR S&P Health Care Equipment ETF
Expense ratio: 0.35%
When it comes to the non-pharmaceutical portion of the healthcare sector, one of the most exciting segments from a growth perspective is medical devices and equipment. The SPDR S&P Health Care Equipment ETF (XHE) is one of just a small number of ETFs dedicated to this industry. XHE follows the S&P Health Care Equipment Select Industry Index.
That’s an equal-weight benchmark, giving XHE’s 67 components a weighted average market capitalization of $19.42 billion, which is lower compared to competing ETFs in this category. That’s not small-cap territory, but it’s small enough that XHE carries a growth feel. With a price-to-earnings ratio of almost 33x, it wouldn’t be fair to call this a value fund.
Components in the $580 million are levered to the FDA approval cycle, meaning this fund can deliver stout short-term gains as well as above-average long-term capital appreciation for the investor that’s willing to accept some added volatility with healthcare stocks.
As of this writing, Todd Shriber did not own any of the aforementioned securities.
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