An ETF for the Graying of America

09/19/2011 8:30 am EST

Focus: ETFS

As boomers get older, there’s going to be a call on specific sectors that promise sizable growth for the next decade or longer, notes Robert Goldsborough of Morningstar ETFInvestor.

With an aging population and longer projected lifespans, Americans will need more medical devices. Like much of the health-care industry, the medical-device subsector offers the tantalizing combination of rapid growth and relative recession-resistance.

iShares Dow Jones US Medical Devices (IHI) has held up nicely during the seesaw-like market activity of 2011, and gives investors access to a basket of the largest medical-device manufacturers, all in one trade.

We like the generally recession-resistant nature of health-care needs. We also like medical-device firms’ dominant market positions in most device niches. And more broadly, we feel that the health-care industry is enjoying a tailwind from some attractive demographic trends—namely, the aging of America.

Medical-device-and-equipment companies manufacture implantable hardware (pacemakers, artificial hips) and instruments (scalpels, robotic systems) that enable surgical procedures. Because product improvements generally are more evolutionary than revolutionary, and because a streamlined regulatory review process often depends on comparisons to other marketed devices, device firms tend to face less regulatory risk than do pharmaceutical companies.

Although regulatory requirements are less onerous here than they are in the pharmaceutical industry, the extremely high innovation and service barriers help medical-device makers maintain oligopoly-like niches. Typically, a handful of small firms dominate device niches, making it difficult for new entrants and weaker players.  

This ETF tracks an index of 39 domestic medical-device stocks. Because the largest device makers are US-based, the index provides good coverage of the worldwide medical-device trade.

The index rebalances quarterly and weights stocks by market cap, subject to certain limits. This fund follows a full replication strategy. The top ten holdings make up 64% of assets. The biggest firms are well-represented, but IHI also owns a slug of midsize names.

IHI’s expense ratio is 0.47%. While some broad health-care sector funds cost less, IHI is the only one offering specific exposure to medical-device firms.

No other ETFs offer targeted exposure to the medical-device industry. Investors can gain exposure to the industry through broad health-care sector ETFs such as iShares Dow Jones US Healthcare (IYH), Vanguard Health Care (VHT) , and Health Care Select Sector SPDR (XLV), which all invest 15% to 20% of their assets in medical-device manufacturers.

 Another option is PowerShares Dynamic Healthcare (PTH), which has the highest correlation in performance with IHI of any health-care ETF.

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