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2 Great Healthcare ETFs in Focus

Zacks Equity Research

Despite uncertainties with regards to the Affordable Care Act, the healthcare segment has been leading the market this year thanks to strong performances by major drug companies in both the broad pharma space and in the biotech industry. In fact, the sector outpaced the broad market (S&P 500) by a wide margin.

However, most of the healthcare stocks, including medical testing, hospitals, insurers and medical device makers, have reported disappointing earnings and revenues in the first quarter. The full implementation of the Affordable Care Act will be over in less than a year, but it has already started to hurt many healthcare companies (read: Healthcare ETF in Focus on Earnings Reports). 

Yet, healthcare ETFs have impressed with their outstanding performances, gaining in double digits. Interestingly, these top performers are spread out among various healthcare segments, and act as one of the most defensive sectors in the U.S. market. This suggests that there have been winners in every corner of the space, implying that those willing to take low risk could invest in this market.

How to Play

Below, we have highlighted two of the top ETF performers which have not only managed to stay profitable, but have provided handsome returns in the year-to-date timeframe (see more in the Zacks ETF Center). Any of the two could, if you believe that the trends will continue, provide investors with more gains in the months ahead and thus be solid picks for the summer months as well:

First Trust Health Care AlphaDEX Fund (FXH)

Launched in May 2007, this product provides a broad exposure to the U.S. equity market with a core focus on the broader healthcare sector. The ETF not only offers holdings in broad segments, but utilizes the AlphaDEX methodology which could be a more quantitative approach to healthcare ETF investing.

With this process, First Trust finds only the most favorable stocks in the segment and gives higher weights to those securities that have impressive valuation or growth metrics. The company also eliminates the bottom 25%, so in theory only the best stocks are taken into the ETF (read: Zacks Top Ranked Healthcare ETF: FXH).

This results in an ETF that has a heavy focus on healthcare providers, and then a big focus on equipment firms. From an individual holdings point of view, FXH has 70 securities in its basket and does well in minimizing concentration risk by allocating just around 25% of its total assets in the top 10 companies.

The fund has amassed an asset base of about $839 million while daily volume is relatively robust at more than 180,000 shares a day. However, investors have to pay a bit more than 70 bps in expense ratio for this more involved methodology.

FXH is up roughly 22% YTD and currently has a Zacks ETF Rank of 2 or ‘Buy’, along with a Low risk rating.

PowerShares Dynamic Healthcare Sector Portfolio (PTH)

This ETF is relatively unpopular with AUM of $61.6 million and average daily volume of less than 8,000 shares. It seeks to match the price and performance of the Dynamic Healthcare Sector Intellidex Index, before fees and expenses.

The index evaluates the companies on the basis of various investment merit criteria, including price momentum, earnings momentum, quality, management action and value.

With holdings of 59 stocks, the product is spread well across various firms putting less than 28% of the assets in top 10 holdings. None of the firms hold more than 3.89% share in the basket. This suggests minimal company-specific risk and prevention of concentration.

This structure results in a growth tilt for the product. PTH has roughly one-fourth of its assets in small cap growth, with just 13% going to value stocks (read: Forget SPY, Focus on Mid and Small Cap ETFs).

Within the healthcare sector, healthcare services and medical equipment collectively comprise more than half of the total assets, while pharmaceuticals and biotechnology make up for the remaining portion in the basket.

The fund has added about 22.5% in the year-to-date timeframe while charging 65 bps in fees per year. PTH has a Zacks ETF Rank of #3 or Hold with Low risk tolerance level.

Bright Outlook

Going forward, the space is a potential bright spot as the U.S. is one of the major markets for healthcare and one of the largest spenders on public health, putting the sector in an advantageous position (read: 3 Sector ETFs Surviving This Slump).

The healthcare sector is expected to remain in the growth territory this year attributable to the aging population and higher rates of chronic disease, growing demand in emerging markets and product launches.

Also, rapid inorganic growth for many companies in the form of mergers and acquisitions will help to make up for the decrease in revenue in the recent past and address the issue for patent expiry for many of their key products.

Further, the pharmaceutical industry is showing signs of recovery from one of the biggest patent cliffs in recent times. Several companies which had faced generic headwinds in the last couple of years should see recovering results this year. Cost-cutting, downsizing, streamlining of the pipeline, growth in emerging markets and product approvals should support growth.

So although the near future of healthcare is uncertain as Obamacare fully gets underway, the long-term outlook looks promising. Health care will remain in demand no matter what happens, especially given the demographic shift in the U.S. and the insatiable demand for new treatments and drugs for a variety of illnesses.

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