A "Healthy" Defense...

03/31/2006 12:00 am EST


James Stack

President, Stack Financial Management

"Perhaps our best piece of advice at this fragile stage of the economic recovery is ‘Don’t buy any stocks that you wouldn’t want to own in a recession,’" notes Jim Stack. "This is the time to be selective." Here he looks at a favorite defensive play on healthcare.

"It’s hard to stay disciplined and defensive as market indexes charge higher, but a quick review of the potential hazards this year should help one remain objective:

  • Interest rates: Analysts widely expect no more than another 1/4% point increase from here they could be unpleasantly surprised.
  • Long bond-yields: These are still low, and that’s been a key underpinning for this bull market. However, the yield on the 30-year Treasury has again started inching up toward our 5% warning threshold.
  • The housing bubble: With housing sales softening and the inventory of unsold homes rising, this party is over. The only question is the severity of the hangover.

"While we are definitely monitoring these pitfalls, there are no major bear market flags flying yet. Hence, we remain cautiously bullish for the present. Thus, o ur current strategy is to focus on sector selection as a means of reducing risk. One such sector that is not vulnerable to rising interest rates and tend to be more immune to economic cycles is healthcare, where we have found an ETF that is a good choice for investors at this stage of the bull market.

"We have added iShares Dow Jones Health Care (IYH NYSE), as the healthcare sector tends to perform well in late stage bull markets. We chose this exchange traded fund in part because of the diversification it offers despite a relatively small investment. For those not familiar with ETFs, we note that they are essentially index funds that trade like stocks and can be purchased or sold any time the market is open, rather than just on the close like traditional mutual funds.

"As index funds, ETFs generally hold a large number of equities, providing broad diversification within a limited segment of the market, and they sport low expense ratios because they are not actively managed. Turnover is minimal, making ETFs a tax-efficient investment, and they have no early redemption penalties or minimum purchase requirements.

"This ETF seeks results which correspond to the price and yield performance of US healthcare stocks as represented by the Dow Jones US Health Care Index. It has nearly six years of history, with an inception date of June 2000, and manages $1.3 billion in assets. The fund holds over 150 stocks with a 57% allocation in Pharmaceuticals and Biotech and 43% in Health Care Equipment and Services.

"iShares DJ Health Care’s top holdings include Johnson & Johnson, Pfizer, Amgen, and UnitedHealth Group, illustrating the fund’s diversity among healthcare industries. The fund’s expense ratio at 0.6% is just one-third the average expense ratio of actively managed healthcare funds. It has a 1% yield and, with a beta of .75, exhibits just ¾ the volatility of the S&P 500. Lower volatility doesn’t mean this investment can’t outperform the market though. In 2005, the return of the iShares DJ Health Care was more than double that of the S&P 500.

"With low expenses, good diversification, and relatively low volatility in a defensive sector, this ETF is exactly what we’re looking for at this stage of the bull market: solid potential with reduced downside risk. In addition to the iShares DJ Health Care fund, we add that two additional ETFs, Vanguard Health Care VIPERs (VHT ASE) and Health Care Select SPDRs (XLV ASE) are amazingly similar and any one of them would be a fine choice for a healthcare investment."

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