The healthcare sector isn’t exactly firing on all cylinders at this point in 2015. Recent political grandstanding about the rising cost of prescription drugs and other medical costs has sent the sector into a freefall.
Just take a look at the Health Care SPDR (XLV) — the broad-based healthcare ETF is off more than 7% since mid-July, making it the worst performer among the original 9 SPDR sector funds.
But there’s plenty of reason not to give up on healthcare stocks.
For starters, demand for healthcare is still there in spades. The Affordable Care Act (aka Obamacare) has pushed an entire segment of the population that previously didn’t have access to medical care into the field. Meanwhile, the “graying” of the U.S. and other developed nations will increase the number of older citizens. Both of these groups will continue to spend big bucks on healthcare long into the future.
Add in emerging markets that are getting increased exposure to and spending more on healthcare as their middle classes expand, and you have a recipe for long-term success.
Investors thinking about the long-term have plenty of reasons to put healthcare stocks on their radar. But rather than take on the expansive risk of a single ruling or trial result hammering a huge chunk of a single-stock investment, investors instead would do well to consider one or more of these best ETFs delving in the healthcare space.
In no particular order …
The Best ETFs for Healthcare Stocks: Health Care SPDR (XLV)
Expenses: 0.14%, or $14 annually for every $10,000 invested
With more than $13 billion in assets and hefty daily trading volume of nearly 2 million shares, the HealthCare Select Sector SPDR Fund (XLV) is the biggest way to track the largest healthcare stocks in the U.S.
XLV mandate is simple to understand. It owns all 57 healthcare stocks that are included in the venerable S&P 500, including sector stalwarts like Johnson & Johnson (JNJ) and Pfizer (PFE).
And while that pool of stocks may be small, the XLV does touch on all the various healthcare subsectors — pharmaceuticals, healthcare services firms, equipment and biotechnology stocks all make an appearance. The fund is heavily weighted (60%) toward drug manufacturers, however.
Still, that hasn’t slowed XLV’s returns. Since inception in December 1998, However, more than 60% of the fund is dedicated to drug manufacturers.
That fact hasn’t stopped the XLV in the returns department. Since the fund’s inception in December 1998, the XLV has returned 8.12% annually to beat the S&P 500. That performance is helped in small part by a modest 1.4% yield.
The Best ETFs for Healthcare Stocks: Vanguard Health Care ETF (VHT)
Expenses: 0.12%
For investors looking for a broader take on healthcare, Vanguard Health Care ETF (VHT) could be the right choice. VHT bumps the number of holdings up from just 58 in the XLV to 338.
The VHT tracks a benchmark including healthcare stocks across the market capitalization spectrum. So while you get exposure to the JNJs of the world, you also have plenty of smaller firms, including life science equipment maker Sequenom (SQNM) and biotech Teligent (TLGT). And while the fund is market-cap weighted, roughly half of the fund is in mid- and small-caps.
That diversification has its benefits. Smaller stocks over long stretches of time do better than larger ones. And healthcare is one sector that this factor very prevalent. Over the past 10 years, VHT has managed to produce an average total return of 11.39%, as of the end of October.
Not too shabby.
The Best ETFs for Healthcare Stocks: iShares Nasdaq Biotechnology ETF (IBB)
Expenses: 0.48%
One of the biggest drags on healthcare stocks broadly has been the biotechnology industry. As biotech companies have pushed the limits of disease control and prevention, the costs for drugs has skyrocketed. However, the worry now is that political pressure could squeeze prices from major biotech drugs, led in the charge by Hillary Clinton in a tweet about “price gouging.”
Maybe. But high prices likely aren’t going anywhere soon, and mostly are bred out of necessity. After all, all the “easy diseases” have been cured, and innovation is expensive.
So don’t fret about biotechs quite yet.
Either way, investing in individual biotech stocks can be like playing the lotto — some big winners, but a lot of duds. That makes the iShares Nasdaq Biotechnology ETF (IBB) the best way to play the sector.
IBB holds 158 different biotech stocks across all market caps, including top holdings Regeneron (REGN) and Amgen (AMGN). That’s important as the industry stalwarts — the ones with actual money-making drugs — balance out the early-stage and/or single-drug healthcare firms with explosive potential but also flame-out potential.
That balance has managed to turn a $10,000 investment to a nest egg north of $43,000 over the past decade — and that includes the recent drops in IBB.
The Best ETFs for Healthcare Stocks: iShares Global Healthcare ETF (IXJ)
Expenses: 0.9%
Bayer (BAYRY), Novo Nordisk (NVO), and Sanofi (SNY) are three of the world’s largest healthcare companies, and not a one of them is American.
Healthcare is a truly global sector, which is why investors might want to expand their horizons to the iShares Global Healthcare ETF (IXJ).
IXJ tracks the world’s largest healthcare firms domiciled in developed markets. The U.S. still dominates at 66% of assets, but the ETF does provide exposure to healthcare giants in Switzerland, the U.K., Japan and other nations. All in all, the ETF holds 90 healthcare large-cap stocks.
The ETF has been struggling versus peers recently, but of that is due to the effects of the rising dollar and not so much fault of the underlying stocks.
Even then, the IXJ has managed to put up an impressive average annual return of 9.5% over the past 10 years.
The Best ETFs for Healthcare Stocks: First Trust Health Care AlphaDEX ETF (FXH)
Expenses: 0.66%
Broad-based index funds like XLV or VHT are great building blocks for portfolios, but if you want to be a bit more tactical, consider the First Trust Health Care AlphaDEX ETF (FXH).
FXH is a so-called “smart beta” ETF that uses various fundamental and quantitative metrics to screen for healthcare stocks that have the ability to outperform. Still, in the end, it’s an index fund — just a “rules-based” one. The StrataQuant HealthCare Index looks at three-, six- and 12-month price appreciation, sales metrics, book value, cash flows and returns on assets when picking FXH’s underlying stocks.
Currently, that’s 76 different household healthcare names that aren’t big pharma behemoths — think Baxter International (BAX) or Health Net (HNT). The vast bulk of the ETFs holdings are in healthcare providers and services, as well as equipment firms. Drug manufacturers make up only about 10% of the total.
So far, FXH has lived up to its billing, producing a nearly 14% annual return since inception in 2007, vs. closer to 10% for the XLV.
The Best ETFs for Healthcare Stocks: PowerShares S&P SmallCap Health Care Portfolio (PSCH)
Expenses: 0.23%
When it comes to healthcare, being small isn’t necessarily a bad thing. Many of the sector’s rising stars in healthcare software, services, distribution and devices are small-cap stocks.
The PowerShares S&P SmallCap Health Care Portfolio (PSCH) is a way to directly invest in those stocks.
PSCH could be seen as the previously mentioned XLV’s smaller sister. The ETF tracks all the healthcare stocks (73) in the small-cap S&P 600. The fund is not pharma-heavy, with only 16% of assets in drug manufacturers. The vast bulk of the fund is invested in equipment and services firms. Top holdings include Magellan Health (MGLN) and Affymetrix (AFFX).
The small-cap tilt seems to be working. Since inception in 2010, it has managed to outperform the broader S&P 600 by 7 percentage points per year.
If you already hold XLV and want to capitalize on the sector’s real growth potential, PSCH could be a nice complementary holding.
As of this writing, Aaron Levitt was long VHT.
