6 best health care funds for a volatile market

  • By Steven Goldberg,
  • Kiplinger
  • – 09/05/2019
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Let’s face it: The stock market is infuriating. Valuations are high, global growth is slow, and President Donald Trump’s trade war with China has brought elevated volatility to stocks. Meanwhile, bonds, the only sensible alternative, are at near-record high prices and thus offer puny yields.

What’s an investor to do? One partial remedy is to increase your investment in health care stocks. Health care, which comprises more than 15% of Standard & Poor’s 500-stock index (.SPX), is the only broad market sector that can hold its own in both bull and bear markets. Although, no question, its best performance relative to the overall stock market comes during selloffs. In 2018, for instance, while the S&P 500 retreated by 4.6% on a total-return basis (price plus dividends), the health care sector gained 5.6%.

Which would you rather have: a shiny new BMW or your health? To ask the question is to answer it. If you’re really sick, you’ll do whatever it takes to recover, no matter the cost. You’ll skip the new car, if necessary. Demand for health care is virtually inelastic. What’s more, as baby boomers age, they’re requiring more medical care. Simultaneously, breakthrough advances in the treatments of diseases – often expensive treatment – continue at a rapid clip.

Below are my six best health care funds, in no particular order.

Fidelity MSCI Health Care ETF and Vanguard Health Care ETF

Conservative investors will appreciate these two virtually identical, broad-based, health care funds: Fidelity MSCI Health Care ETF and Vanguard Health Care.

Both cheap index funds cover the entire health care waterfront. They each have 28% of assets in pharmaceutical companies, roughly a quarter in health care equipment and 19% in biotechnology. The rest of each fund’s assets is distributed among managed care (including health insurance companies), life sciences tools, and health care services, supplies and facilities.

The funds track MSCI health care indexes – market-capitalization-weighted benchmarks of U.S. health care stocks. Consequently, they’re both dominated by the industry’s giants. Top holdings include the likes of Johnson & Johnson (JNJ), UnitedHealth (UNH), Merck (MRK), Pfizer (PFE) and Abbott Laboratories (ABT).

The weight in mega-cap pharmaceutical stocks limits both the upside and downside of these health care funds. The big pharma companies still develop some innovative therapies. But mainly they either buy up or partner with small biotechnology companies that invent most of the breakthrough medical treatments nowadays.

For many investors, broad-based funds such as these will work better than a more aggressive product. You won’t get the huge gains that you can in biotech, but you’re unlikely to get killed in a market downturn either.

The primary difference between the two: Vanguard’s ETF charges 0.1% in annual fees while Fidelity’s charges 0.08%. Big whoop. On a $10,000 investment, the two-basis-point difference (a basis point is one one-hundredth of a percent) comes to a puny $20 per year. On the flip side, the Vanguard fund actually has slightly outperformed Fidelity’s over the past five years.

SPDR S&P Biotech ETF

If broad health care funds such as the two above are relatively conservative, biotechnology stocks are among the most volatile equities you can find. SPDR S&P Biotech ETF, another index ETF, is more than twice as volatile as the S&P. Indeed, it lost 15.3% in 2018, or more than thrice the S&P’s deficit.

Biotech is an industry that has lots of strikeouts – and a few home runs.

Alex Bryan, a senior analyst at Morningstar, nevertheless likes this ETF for people who want to invest a portion of their money in biotech. That’s primarily because the fund invests in 119 different stocks, and the largest holding – Genomic Health (GHDX) – is a mere 2.2% of the fund’s total assets, thanks to XBI’s “modified” equal weighting.

“In biotech, you don’t want to have a lot riding on a couple of names,” Bryan says, because most biotech firms will rise or fall depending on how successful one or two treatments are.

Vanguard Health Care Investor

Vanguard Health Care Investor (VGHCX) aims to beat a health care index similar to the one tracked by FHLC and VHT. Over time, I think the active fund will prove superior, but it has plainly stumbled in the past three years.

My confidence comes from a long-term record that tops the index. Over the past 10 years, this Kip 25 mutual fund has returned an annualized 13.6% compared to 12.4% for the benchmark. Longtime manager Ed Owens retired in 2012, but Jean Hynes, who took his place, has worked on the fund since graduating from college in 1992.

Hynes and her team invest almost exclusively in large-cap stocks because VGHCX, with $43.3 billion in assets, is too big for small caps to have much impact. The fund is widely diversified, including more than 25% in foreign stocks. Hynes doesn’t like to trade; stocks stick around an average of about 10 years.

The fund’s biggest focus is pharmaceuticals, which comprise 45% of assets. Only about 15% is in biotech, which helps keep volatility low. In short, this is a large-cap conservative health care fund that is unlikely to cause investors sleepless nights.

The fund’s recent underperformance, however, is yet another illustration of how hard it is for even the best-managed, least-expensive funds to beat an index. This fund, incidentally, charges just 0.34% annually – less than the SPDR S&P Biotech ETF, a passive vehicle that requires no brilliant moves from a manager.

In my view, VGHCX is likely to outperform the index, but it’s clear that both the active and the index versions of these broad-based health funds offer good value.

T. Rowe Price Health Sciences

No fund better illustrates the breadth and depth of T. Rowe Price’s (TROW) managers and analysts than T. Rowe Price Health Sciences (PRHSX). Longtime star manager Kris Jenner left in 2013. Then in 2016, Jenner’s replacement, Taymour Tamaddon, became a manager on T. Rowe’s large-cap equity team. Since 2016, Ziad Bakri has piloted the $12.3 billion fund.

That kind of rapid shuffling in leadership often leads to disappointing fund returns. But through all this turnover, PRHSX has continued to post superb results.

In the past 10 calendar years, T. Rowe Price Health Sciences (PRHSX) never finished in the bottom half among health care funds. Over the past 10 years, it returned an annualized 18.4% – an average of 3.6 percentage points per year better than the S&P Composite 1500 Health Care Index (.SPSUPX). That puts it in the top one percentile among its peers.

PRHSX is my favorite health care fund for moderate-to-aggressive investors. Bear in mind, though, that the terrific returns come with some extra risk. The fund typically invests about one third of assets in biotech – almost double that of the S&P Health Care index. It also invests a healthy slug of assets in mid- and small-cap stocks.

Fidelity Select Health Care

Eddie Yoon has run Fidelity Select Health Care (FSPHX) successfully since 2008. Over the past 10 years, it returned an annualized 17.1% – in the 90th percentile of its competition, and tops among all the health care funds in this article, with the exception of the more volatile T. Rowe Price fund. FSPHX is, however, riskier than Vanguard Health Care Investor (VGHCX) and the Vanguard and Fidelity index ETFs.

Yoon, assisted by about a dozen analysts, splits the portfolio into three parts. He puts roughly 45% of assets into stable firms with steady growth outlooks, about the same percentage into faster-growing established companies, and the remaining 10% or so into biotechs and other emerging businesses with innovative approaches.

He underweights the big pharmaceutical companies, frustrated with the lack of innovation from this sector. The fund has only about 17% in pharma – much less than you’ll find in most broad-based health care index funds.

Instead, Yoon puts more emphasis on biotech (25%) and health care equipment (29%). In fact, two of his largest holdings are equipment giants Boston Scientific (BSX) and Becton Dickinson (BDX). In all, the fund owns nearly 100 stocks, but almost half of assets are in the top 10 holdings.

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