Total expenditure in the health care industry amount to $1.6 trillion a year and annual growth has been consistently above inflation. Along with favorable demographics momentum it could pay off for investors to allocated portion of the portfolio to the healthcare sector.
The healthcare industry can be divided into 4 specific segments. Just like the Energy ETFs not all ETF in healthcare sector is the same. Each sub sector has its own risk and reward profile. The best healthcare exchange traded fund for each sector is profiled so investors can make the right fund selection decision for the portfolio.
Healthcare ETF List
|Health Care Select Sector SPDR||XLV||Diversified Healthcare Sector|
|iShares Biotech ETF||IBB||Biotechnology ETF (BioTech)|
|iShares U.S. Pharmaceuticals ETF||IHE||Pharmaceutical ETF (Medical Treatment or Consumer Health)|
|iShares Dow Jones Medical Devices||IHI||Medical Device and Equipment Makers|
|Health Care REIT Inc.||HCN||Healthcare Real Investment Trusts (Health Care Real Estate i.e Hospitals, Senior Housing and Medical Offices)|
|iShares U.S. Healthcare Providers ETF||IHF||Healthcare Service Providers (Insurance, Diagnostics and Specialists)|
|ProShares Ultra Health Care||RXL||2x Healthcare Leverage ETF|
|Direxion Daily Healthcare Bull 3x||CURE||3x Healthcare Leverage ETF|
|ProShares UltraShort Health Care||RXD||Inverse Healthcare ETF|
Diversified Healthcare Sector ETF
Health Care Select Sector SPDR (XLV) is the most well known and largest listed healthcare ETF. For most investors that are looking for a diversified exposure sectors with large, mature and stable cash flow companies then XLV can be one of the best healthcare sector ETFs.
Since inception in 1998, it had an annual return of just below 9% compounded (excluding dividends). XLV expense ratio is 0.17% and tracks S&P Healthcare Index which includes the largest healthcare stocks in the S&P 500 index. The index includes the largest market capitalized and liquid firms, this is reflected in the underlying holdings as it only has 55 health care companies in the fund even with $9 Billion under management.
Analysis of the top industries in XLV shows although it contains a combination of pharmaceuticals, biotechnology and medical devices companies it is still heavily reliant on pharmaceuticals and biotechnology stocks. These 2 sectors combined accounts for 64% of the fund.
|XLV Top Industries Exposure (%)||%|
|Health Care Providers & Services||16%|
|Health Care Equipment & Supplies||15%|
|Life Sciences Tools & Services||3%|
|Health Care Technology||1%|
From comparing the the Top 10 holdings of XLV with IBB. Top 10 holdings in both ETFs account for more than half of the fund. The difference for XLV is its main holdings are household names in the consumer healthcare sector such as J&J, Merck and Pfizer while IBB is in specialized bitotechnology drug research and development.
Largest Biotechnology ETF
iShares Biotech ETF (IBB) is an index tracker ETF that mimic the returns of the US biotechnology and pharmaceutical stocks on the NASDAQ biotechnology index. It is the largest listed specialized biotech ETF. Although there are over 150 companies in IBB there is a concentration risk as the top 10 stocks account for 54% of the total value.
|IBB Top 10 Holdings||%|
|BIOGEN IDEC INC||9.5%|
|GILEAD SCIENCES INC||6.8%|
|REGENERON PHARMACEUTICALS INC||6.6%|
|VERTEX PHARMACEUTICALS INC||3.8%|
|ALEXION PHARMACEUTICALS INC||3.3%|
Investing in the Biotech sector is not for everyone as the sector is at the highest end of the risk spectrum in the healthcare sub sector. As with any investment, there are inherent risks. Daily volatility and sharp drawdowns in pricing is a common occurrence for this sector. The upside is that it provides the highest potential return out of all healthcare sector ETFs.
Income focused should think about utilities ETFs which can provide a steady income stream.
At next level down. SPDR S&P Pharmaceuticals ETF (IHE) is a dedicated exposure to traditional pharmaceutical companies that make over the counter drugs or vaccines. Unlike biotechnology stocks, usually pharmaceutical companies are more mature with a earning visibility.
As you would expect IHE is dominated by well known consumer pharmaceutical producers like Johnson & Johnson, Pfizer and Merck. Around 10% of the IHE is also invested mature biotech stocks. These a more mature biotechs with actual earnings.
Healthcare Medical Device and Equipment ETFs – Steady as She Go
The largest pure play on the medical device sector is the iShares Dow Jones Medical Devices (IHI). Only healthcare stocks that directly manufacture, distribute and sells medical device and equipment are included in the index.
IHI is designed for those that would like to limit drug research and development risks and avoid the long lead time and costs it take to bring the product to the market. Medical device companies still have the same research and development risks as pharmaceutical and biotechs but it be from a manufacture, development and distribution angle.
IHI has also outperformed main diversified health care ETF, Health Care Select Sector SPDR (XLV) over the last 5 years.
The Best Heathcare REIT
The returns of the above healthcare ETFs are driven by capital gains from rise in the ETF price. For investors who are reluctant to realise capital gains and looking for consistent quarter on quarter income from their portfolio while still maintain some exposure to the healthcare sector. Health Care REIT is on viable alternative in achieving all of the above.
Health care REITs are attractive for investors as heath care real estate are long term in nature, investors in healthcare REITs earns consistent and growing income overtime. This is especially attractive under the current interest rate environment.
Health Care REIT Inc. (HCN) is a Real Estate Investment Trust. Structure of HCN can be seen similar to a listed close end fund with daily pricing. HCN provides diversification through various real estate asset classes range from Senior Housing, Nursing Homes, Medical Offices, Hospital and Life Science with national geographical coverage across the United States and Canada (to an extent also the UK).
There are certain benefits for investors for HCN to be incorporated as a REIT:
1) Income is not taxed at the REIT level. Investors only pays taxes on the income of the assets once unlike company dividends where it is first taxed at the company level then again when the investor receives the dividend.
2) For an entity to be classified as a REIT, it must pay out 90% of the income annually. This avoids issues seen in the mature companies where companies hoard the cash flow generated by the business and in some cases not in the best interest of shareholders.
Healthcare Service Providers ETF
iShares U.S. Healthcare Providers ETF (IHF) is a pure sector play on the best service providers of healthcare in the US. It is heavily weighted towards healthcare insurers with 4 insurers in the top 5 holdings accounting for more than 30% of the fund. Express Scripts is the largest non insurer in the fund at 11% of the ETF AUM. See also our Insurance Exchange Fund analysis for the breakdown on the best Insurance ETFs.
Overall size of IHF is smaller than the other sector specific ETFs. However there is limited liquidity risk due to average market capitalization of the stocks in the ETF at around $20 Billion and larger. From the volatility angle the beta of ETF is estimated to be 0.73 which is considerably less than the overall market.
Investors should mix and match the best healthcare ETF providers above in creating the right balance of risk and reward that correspond the risk tolerance of the portfolio. The list above is not an exhaustive or exclusive list but highlights the best healthcare ETFs within each sector that can act as the starting point.
2x and 3x Leveraged Health Care ETFs
High risk investors wanting leveraged healthcare ETF exposure can use Direxion Daily Healthcare Bull 3x (CURE) and ProShares UltraShort Health Care (RXL). CURE from its name is a 3x leveraged health care ETF and RXL is a 2x leveraged ETF. Investors should be cautious that these track daily movements in the health care stocks in the S&P 500 which is a cap weighted index. The leveraged health care ETF has the exact stock position as XLV but at 3 times the leverage. Investors should be aware that it should not be used over a long term but as trading instruments only. 3x short health care ETF position is created by shorting CURE.
Inverse Health Care ETF
Investors with a bearish view on the health care sector can express their view with ProShares UltraShort Health Care (RXD). Again this is perfect trading instruments on short term sector positioning and hedging. It is not recommended for long term investors use these ETFs.