Health Care ETFs at Inflection Point

Sunday, January 11, 2009

Early in 2008, we noted that health care was one of few industries with robust demand forecasted many years into the future. So why did health care ETFs take a dive during the final months of the Presidential election? Valuations are historically attractive for this critical mega-sector which is represented by an impressive number of ETFs.

Three plain low-cost ETFs track broad health care indexes and correlate highy. These include SPDR Health Care Select Sector (AMEX:XLV) at .25% annual fees, iShares Dow Jones US Healthcare (NYSEArca:IYH) at .48% and Vanguard Health Care (AMEX:VHT) at .25% fees. With such high correlation as the graph below shows, we see no reason to stray from the two most competitively priced ones.

Also, three fundamental ETFs attempt to beat the major indexes with alternative weighting schemes. These include PowerShares FTSE RAFI Health Care (NasdaqGM:PRFH) and PowerShares Dynamic Healthcare (AMEX:PTH) both at with .60% annual fees, and First Trust Health Care AlphaDEX (NYSEArca:FXH) at .70% fees. As the graph shows, they offer a higher degree of volatility (ie., risk) and in this period at least underperformed the standard index ETFs. For this privilege, investors should pay more in annual fees? In fairness, over the long run fundamental index methodologies may well prove superior to cap-weighted indexes.

Health care firm prices plunged just as polls showed Barack Obama the likely winner of the Presidential election, and it may reflect concern for major pharamaceutical firms' profits or for his pledge to negotiate better pricing from pharmaceuticals' in the giant Federal health programs. He also promised to set up a national health insurance system which is sure to displace highly profitable private ones. President Obama is not the natural ally of the health care shareholder.

Perhaps shareholders simply realized that the current trajectory of health care cannot continue. Just before the election the Centers for Medicare & Medicaid Services (CMS) announced that Medicaid benefits spending will grow at an annual average rate of 7.9 percent over the next 10 years, far above a projected rate of growth of 4.8 percent in the general economy. Outgoing Health and Human Services Secretary Mike Leavitt, a Republican, said the current path of Medicaid spending is unsustainable for both federal and state governments. If nothing is done to rein in these costs, access to health care for the nations most vulnerable citizens could be threatened. The writing is on the wall on both sides of the political spectrum. Someone is going to take a scalpel to medical costs, and those projections may never occur. As a result, health care may have deserved the drop in valuations.

Nonetheless, the fundamental need cannot be ignored. Baby boomers are getting older and will need more and more care.

There are quite a few specialized health ETFs, some drilling down into remarkably small sub-sectors. Probably the most prominent is biotech, despite being a relatively small sub-industry. It has explosive growth potential. Biotech ETFs include:

  • First Trust AMEX Biotech (AMEX:FBT) 0.60%
  • Invesco PowerShares Dynamic Biotechnology & Genome (AMEX:PBE) 0.60%
  • Invesco PowerShares Global Biotech Portfolio ETF (NasdaqGM:PBTQ) 0.75%
  • iShares Nasdaq Biotechnology (AMEX:IBB) 0.48%
  • SPDR Biotech (NYSEArca:XBI) 0.35%
  • Invesco PowerShares Dynamic Biotechnology & Genome (AMEX:PBE), 0.6% fees

Various other sub-sector ETFs include:

  • iShares Dow Jones US Healthcare Provider (NYSEArca:IHF), 0.48% annual fees
  • Invesco PowerShares Dynamic Healthcare Sector Portfolio (AMEX:PTH) 0.6% fees
  • Invesco PowerShares Dynamic Pharmaceuticals ETF (AMEX:PJP) 0.6% fees
  • Invesco PowerShares FTSE RAFI Health Care Sector Portfolio (NasdaqGM:PRFH) 0.6%

International and global ETFs include:

  • Invesco PowerShares Global Biotech Portfolio (NasdaqGM:PBTQ) 0.75%
  • iShares S&P Global Healthcare Sector (NYSEArca:IXJ) 0.48%

And finally several leveraged ETFs allow traders to place aggressive bets on the industry.

  • ProShares Ultra Health Care (AMEX:RXL) 0.95%
  • ProShares UltraShort Health Care (AMEX:RXD) 0.95%
  • Rydex 2x S&P Select Sector Health Care (AMEX:RHM) 0.7%
  • Rydex ExpressShares S&P Equal Weight Health Care (AMEX:RYH) 0.5%
  • Rydex Inverse 2x S&P Select Sector Health Care (AMEX:RHO) 0.7%

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.