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What to Expect From Health-Care ETFs


How to invest in the sector and what to look for in its funds.

The health-care sector has been all over the map this year, with some investors seeing it as a safe bet during a recession and others shying away from the uncertainty caused by potential health-care reform in the US.

Now that President Barack Obama and Congress have made it clear that they can't agree on anything, many investors are looking at where they can find some good value in these stocks. Exchange-traded funds have carved up the sector relatively well, offering investors everything from a broad view with the Vanguard Health Care ETF (VHT), which gives investors a pretty good mix of large-, medium-, and small-cap stocks, to more niche offerings like PowerShares Dynamic Healthcare Services (PTJ), with top holdings in WellPoint (WLP), Humana (HUM), and UnitedHealth (UNH).

Morningstar analyst John Gabriel recommends knowing what you own when investing in ETFs, he says "the industry breakdowns can vary widely from fund to fund." He suggests taking a look at the fund by how it breaks down into various industries (i.e. pharmaceuticals, biotechs, medical devices, and service providers). He also suggests looking at what percentage of the fund is exposed to large caps, mid caps, and small caps.

Another important factor when investing in ETFs is to look at how many companies are included in the fund -- this will give you a better idea of how deeply rooted the fund is in each company or if it only has shallow exposure to each of its holdings.

Despite ETFs covering the same sector, their holdings -- and thus their performance -- can vary widely. ETF Database senior analyst Michael Johnston looked at the differences in five biotech ETFs in a recent article from the site. He points out First Trust Biotech ETF (FBT) is up 24.4% year-to-date compared with Biotech HOLDRS (BBH), up only 6.4%. The difference comes from some of the funds' major holdings -- FBT has a good portion of its holdings in Sequenom (SQNM), OSI Pharmaceuticals (OSIP), Millipore (MIL), and InterMune (ITMN), which have all been major gainers this year -- while BBH has no exposure to any of these stocks.

(See InterMune Still Has Lingering Questions)

(See The Battle for OSI Pharma)

Johnston added during a conversation with Minyanville that the iShares Dow Jones US Pharmaceutical Fund (IHE), which focuses on large-cap pharmaceutical companies including Johnson & Johnson (JNJ), Pfizer (PFE), and Merck (MRK), is due for an uptick sometime soon after underperforming recently. The fund has year-to-date total returns of 30.47%, while the Dow Jones US Select Pharmaceuticals Index is up 31.06%.

"The iShares Medical Device Index Fund (IHI) is something that could see some big government subsidies and is differently positioned from the rest of the industry to benefit from health-care reform should it happen," said Johnston. The medical device ETF includes significant holdings in Medtronic (MDT), Thermo Fisher Scientific (TMO), and Stryker (SYK) with year-to-date returns of 38.34%.

(See Medical Device Makers Brace for Change)

A survey done by Leerink Swann in early February showed that the sector should expect flat spending from hospitals this year -- an improvement over last year when most hospitals were cutting budgets, particularly medical device spending. The survey also showed that hospitals expect procedures to stay flat or increase, also an improvement over last year -- meaning more medical devices are going to be needed for these procedures.
No positions in stocks mentioned.

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