Health ETFs Are Prescriptions for Profit

09/17/2007 12:00 am EST

Focus: ETFs

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Carlton Delfeld, editor of the Chartwell Advisor Global ETF Report, says health care exchange traded funds give investors many ways to gain from the growing demand for health services.

America is spending about $2 trillion a year on health care, and it is escalating at the alarming rate of 9% per year. If nothing is done differently and current cost and budget trends continue, America risks becoming an economic basket case.

But what if instead of just treating diseases, we focused our efforts on breakthroughs that cure diseases such as diabetes? For every cure, the budget savings to consumers and the government would be enormous. But this is not the business model of Big Pharma but rather of smaller, more entrepreneurial firms.

Interestingly, half of the 4,500 drugs in Phase III clinical trials are being developed by mid-cap, small-cap, and even micro-cap companies. These firms have a harder time raising capital to fund their research and development while investing in these firms is of course a riskier proposition. Many will fail, but the few that succeed will do so on a spectacular scale. But how is the average investor supposed to figure out which firms have the best chance of succeeding?

ETFs to the rescue! Instead of trying to pick individual stocks, why not invest in a basket of them equally weighted and let nature take its course? HealthShares offers investors a menu of ETFs that focus in on vertical segments of the health care industry. Think of it as going hunting for big gains with both your shotgun and your rifle.

The broadest ETF is HealthShares Composite ETF (NYSE: HHQ), which features 80 stocks. Other ETF choices include critical areas such as neuroscience, emerging cancer, orthopedic repair, and infectious diseases. (It closed above $27 Friday-Editor.)

Take the HealthShares Cardiology ETF (NYSE: HRD), which contains companies trying to develop products to reduce the $400 billion plus that Americans spend annually on cardiovascular disease and stroke. HRD's universe of companies is global, with market values between $200 million and $15 billion; mid-cap companies account for 55% of exposure.

There are 22 companies in the ETF basket, which is close to optimal in terms of the trade off between diversification and return. Even better is its low correlation [with] the Standard & Poor's 500 index at only 0.61. I also like the way the companies are roughly equally weighted in the ETF basket, with the highest company weighted at 4.5% and the lowest at 3.5%. Like all HealthShares [ETFs], HRD is normally rebalanced and reconstituted on a quarterly basis. (It closed below $23 Friday-Editor.)

Perhaps the most intriguing of the HealthShares ETFs is the Diagnostics ETF (NYSE: HHD), which goes to the heart of the mission of analyzing and diagnosing diseases so that they can be prevented and cured. This ETF also highlights a bonus of many of the HealthShares funds: many of the companies in their ETF baskets are potential takeover candidates. (It closed above $31 Friday-Editor.)

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