Healthy Gains from Healthcare ETFs

02/21/2014 9:00 am EST

Focus: ETFs

David Fabian

Managing Partner, FMD Capital Management

 

Healthcare has been on a major hot streak; the combination of our aging population and strong demand for medical services has boosted the prices of healthcare stocks to fantastic levels, suggests David Fabian of FMD Capital Management.

My preferred choice is to select a basket of stocks that offer access to a wide swath of industries that are focused in multiple areas. There is no easier way to do this other than through a low-cost exchange-traded fund.

The most widely held ETF in this sector is the SPDR Healthcare Select Sector (XLV), which contains 56 large-cap companies primarily engaged in the pharmaceuticals, biotechnology, and medical provider fields.

XLV controls nearly $9 billion in total assets and charges a modest expense ratio of just 0.16%. In 2013, this ETF gained 41.21%, which handily beat the 32% return of the S&P 500.

XLV is probably one of the easiest ways to get broad-based exposure to the healthcare sector in a very liquid vehicle.

More aggressive investors may be interested in honing in on an industry group like biotech stocks that have been a rocket ship of momentum. The iShares NASDAQ Biotechnology ETF (IBB) has over $5 billion invested in 123 companies focused on developing new, innovative pharmaceutical and medical devices.

In 2013, this ETF returned a whopping 65.47% gain on the back of stellar performance from some of its largest underlying holdings. Last year wasn't necessarily a fluke either, IBB boasts three-year annualized returns of 34.67% and five-year annualized returns of 26.52%.

Biotechnology stocks are known to be more volatile because of their hit-or-miss business models, which, often times, lead to periods of strong outperformance or underperformance.

Often times, their stocks are affected by factors such as FDA approval, drug trials, R&D costs, and other unforeseen events. However, they can also lead to big profits when new products are developed and successfully tested.

Another interesting ETF that treads the line between passive and active investing in the healthcare field is the First Trust Health Care AlphaDEX Fund (FXH). This ETF is a smart beta strategy that screens healthcare stocks for book value, cash flow, and return on assets.

It then weights the components according to their scores in these categories. Because the index is rebalanced quarterly, it is being refreshed with companies that have strong fundamental business characteristics.

FXH currently has nearly $2 billion invested in 76 companies. One of the benefits of this strategy is that you get a broader subset of healthcare stocks that include more small- and mid-cap companies, as opposed to just large-cap names. The total return of this ETF in 2013 was 47.55%.

These ETFs have been aggressively bought on nearly every dip down to their 50-day moving average. I would not be hesitant to add to this sector on a modest pullback that gives you a better opportunity for long-term success.

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