U.S. Markets open in 5 hrs 48 mins

Sharpe ratio shows healthcare ETFs are a strong relative investment

Amritpal Khalsa

Adjusting performance on a risk basis

As new insurees flood the insurance market and baby boomers approach retirement, the healthcare space should expect dramatic increases in demand. Alongside an increase in demand, however, has been a tightening of reimbursement policy and a more stringent regulatory environment. These variables present unique risks and opportunities for healthcare funds. Although the healthcare sector has been performing very well this year, it’s important to step back and assess the risk-versus-reward attributes of these funds. This analysis allows investors to develop an investment strategy that matches their return need with the amount of risk they’re comfortable taking on.

In order to now analyze the risk-versus-reward attributes of these funds, we can find Sharpe ratios and use comparative performance analyses to invest more safely. Following the comparison, we can see which funds are taking on greater risk and so come to a conclusion on healthcare funds.

Generally, Sharpe ratios work best over a period of three years, so we can’t include some prominent healthcare ETFs with inception dates within the last three years. Using longer periods allows us to see how the fund performs through a myriad of economic environments.

Look at healthcare funds versus S&P

For our comparison, I took the top 20 healthcare ETFs by average trading volume that have inception dates earlier than the past three years. I grabbed a ten-fund representative sample of sector, biotech, device, pharmaceutical, and provider funds. Here are their three-year Sharpe ratios compared to the S&P 500 (SPY) for reference.

(Read more: Why we could see a new trend in Japan’s exports and imports)

Healthcare ETFs can be a safe investment with great returns

As you can see from the graph, healthcare ETFs have performed amazingly in the past three years. What’s even more notable is that with the exception of IHI, they have been generating returns greater than or equal to the S&P with less volatility. A glance at the five-year ratios shows similar data. These ETFs can be a great, safe add to your portfolio—generating great returns with lower risk.

(Read more: Does “Abenomics” mean a new era of yen depreciation?)

More From Market Realist