Obamacare is driving mergers and acquisitions in the insurance space, while big-pharma is snatching up biotechs to replenish aging drug pipelines. In other words, consolidation could continue.
Yesterday brought us news of another merger, with health insurance giant Aetna announcing its plans to take over Coventry Health Care for $5.7 billion.
This merger follows Cigna’s takeover of HealthSpring last November and WellPoint’s merger with Amerigroup earlier this year.
Larger insurance players are targeting smaller rivals with a strong foothold in the Medicare and Medicaid markets, as demand for these programs is expected to increase dramatically due to Obamacare in the coming years.
Adding to the phenomenon is that consolidation is not just specific to insurance alone.
Last year, pharmacy-benefits manager Express Scripts gobbled up Medco for $29 billion. Gilead purchased Pharmasset, while this year GlaxoSmithKline and Bristol-Myers Squibb finalized their mergers with Human Genome and Amylin Pharmaceuticals, respectively.
Throw all this M'A activity together with the Supreme Court upholding Obamacare in late June, and with the wall of baby boomers set to retire in the coming years, and you get a red-hot sector in play.
Not All ETFs Are Created Equal
Naturally, one would expect all health care ETFs to be on a tear, right? Well, that depends on the ETF.
There are now 18 U.S. health care ETFs that range from broad-based to sector-specific funds. Broad-based health care ETFs encompass the following subsectors:pharmaceuticals, providers ' services, equipment ' supplies, and biotech.
Let’s look at sector-specific funds first.
I’ve charted four iShares ETFs representing each of the four health care subsectors:
- iShares Dow Jones U.S. Pharmaceuticals Index Fund (IHE)
- iShares Dow Jones U.S. Healthcare Providers Index Fund (IHF)
- iShares Dow Jones U.S. Medical Devices Index Fund (IHI)
- iShares Nasdaq Biotechnology Index Fund (IBB)
Understand that I’m comparing iShares funds here not necessarily because they’re the best funds, but because they’re all cap weighted, and attempt to represent broad exposure to their respective market segments.
Despite all the buzz in health care, over a one-year period, IYH and IHF performed relatively in line with the broad market, as measured by SPY, while actually IHI underperformed. It’s really the biotechs (IBB) and pharmaceuticals (IHE) that are clearly outperforming. In fact, biotech ETFs have been some of the top-performing funds in the first half of the year.
While it might be tempting to jump into biotech, it’s important to remember that this sector represents a high-beta play on the health care space. So while biotech might outperform on the upside, should markets sour, it may see more volatility on the downside as well.
Therefore, most investors looking to invest in health care for the long haul might consider taking a broad-based approach.
The broad-based health care segment is currently dominated by three funds.
XLV and VHT are the cheaper options, with 0.18 percent and 0.19 percent annual expense ratios, respectively, compared with IYH’s 0.47 percent. VHT is the broadest in scope, while XLV is concentrated in the 50 largest names.
Despite these differences, the top holdings and weightings between these three funds are virtually identical. Pharmaceuticals account for nearly 50 percent of each of the funds’ weightings, with the “Big Three”—J'J, Pfizer and Merck—having especially big allocations.
Investors who don’t want such a heavy pharma exposure have other options.
For example, the Guggenheim S'P 500 Equal Weight Health Care ETF (RYH) is an equal-weighted version of XLV that is heaviest in equipment suppliers—36 percent. Those wanting greater biotech exposure might consider First Trust’s up-and-coming alpha-seeker, the First Trust Health Care AlphaDex Fund (FXH).
The PowerShares Dynamic Healthcare Sector Portfolio (PTH) meanwhile has a significant insurance component, while the PowerShares S'P SmallCap Health Care Portfolio (PSCH) is a high-beta play on the broad industry that specifically targets small-caps.
As is increasingly the case in the ETF industry these days, there are plenty of ways to access this portion of the investment universe, and doing your homework will help you avoid unnecessary surprises.
At the time this article was written, the author had no positions in the securities mentioned. Contact Dennis Hudachek at firstname.lastname@example.org.
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