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The Size Effect Is Working With Health Care ETFs

ETF Professor

Investors solely focusing on large-cap health care stocks and exchange-traded funds this year are likely disappointed. Entering Tuesday, the Health Care Select Sector SPDR (NYSE: XLV), the largest ETF by assets tracking the sector, was up just 0.2 percent year-to-date. That's merely a third of the S&P 500's year-to-date gain as of April 16.

For investors willing to take on a little more risk with their health care investments, noteworthy is the fact that the size effect is working with health care stocks this year. Just look at the PowerShares S&P SmallCap Health Care Portfolio (NASDAQ: PSCH).

PSCH, the small-cap answer to XLV, added almost 1.5 percent on Tuesday on its way to a record high. The small-cap health care fund was one of just 10 ETFs to hit all-time highs Tuesday and with that gain, PSCH is up nearly 19.7 percent year-to-date.

More About PSCH

The $432.2 million PSCH, which turned eight years old earlier this month, follows the S&P SmallCap 600 Capped Health Care Index, the health care offshoot of the widely followed S&P SmallCap 600 Index.

“The Index is designed to measure the overall performance of common stocks in the health care sector. Included are healthcare companies principally engaged in the business of providing healthcare-related products and services, including biotechnology, pharmaceuticals, medical technology and supplies, and facilities,” according to PowerShares.

Investors often think biotechnology when they think of small-cap health care names. To an extent, that scenario plays out with PSCH, but smaller biotechnology stocks aren't the primary drivers of PSCH's 2018 upside. Biotechnology is merely the ETF's third-largest industry weight at 17.20 percent. Medical device and equipment makers and health care services providers combine for over 63 percent of the fund's roster.

Paying Up

Biotechnology or otherwise, smaller health care companies are often classified as growth stocks and that is true of PSCH's roster. Over 51 percent of the fund's 75 holdings are classified as small-cap growth stocks another 22.66 percent are mid-cap growth names. Just 3.58 percent of PSCH's holdings are designated as value stocks.

With that, PSCH has a price-to-earnings ratio of 43.14, giving it the feel of an Internet or technology fund while implying valuations that are significantly higher than large-cap health care and broader small-cap benchmarks.

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