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ETF News And Commentary

Although some of the less cyclical sectors in the market have struggled in 2012, arguably the most vital of segments, the healthcare industry, has managed to hold its own over the past few weeks. While broad products like the Health Care SPDR (XLV) have lost out to SPY so far this year, the performance of the popular sector fund over the past one year period has thoroughly crushed the benchmark index. A similar trend has also developed when investors look at the various subsectors of the health care industry as well. While biotech has been a star performer, those in the provider space have performed about as good as the market while pharmaceutical ETFs have struggled to keep pace in year-to-date terms.

Yet while investors focus in on these three types of health care ETFs, many are overlooking a relatively obscure segment of the space that has also had a good start to the year and could be an interesting addition in a portfolio. That segment is what is known as the medical device or equipment sector, and can provide investors with a new way to play health care that is seeing strong gains. This could be especially true given some of the key differences that this corner of the market often has when compared to other parts of the health care market (read Five ETFs To Buy In 2012).

First, investors should note that companies in this corner of the sector tend to make crucial products which are used in a variety of medical applications. Many have strong patents on many of these goods but the barriers to entry in this segment are often lower than in other corners of the health care world (although still relatively high overall). Thanks in part to this, profit margins are generally lower although the safety of these companies is pretty high when compared to other sectors (see Utility ETFs: Slumping Sector In Rebounding Market).

However, it should be noted that while many firms in this corner of the market sell goods that need to be replenished quite often, a large number also focus on more durable goods such as MRI scanners or X-ray machines. Obviously, these goods do not have to be replaced often and can be more impacted by broader economic trends and may only be purchased during good economic times, implying that broad health care trends may not always impact this fund as much as other corners of the market.

This contrasts sharply with many of the other health care segments at this time, and especially with the major drug manufactures. Biotech firms are often quite risky, and while they are performing well right now, can see high periods of volatility in short periods of time. Meanwhile, big pharma is seeing collapsing drug pipelines while prospects for new drugs remain slim to say the least. Thanks to these trends, as well as the uncertainty over the health care provider segment given the upcoming election, health care device makers could be a lower risk way to play the broad sector (see Three Low Beta Sector ETFs).

Additionally, investors should note that many companies in this segment do not find their way as big quantities into other, more diversified products. Medical equipment makers only make up about 16% of funds like XLV while they make up just 2% in SPY, suggesting most investors have minimal exposure, at best, to this segment of the industry. Luckily, for those looking to make an allocation to the space, there are two focused ETFs that can offer excellent exposure to the medical device and equipment market.

While they may appear similar at first glance, and hold many of the same companies, there are actually some key differences between the two. So for investors who are intrigued by the merits of the health care sector, but are wary of pharma or healthcare providers, the breakdown of the two medical device ETFs below should be very helpful in determining the correct pick for a well diversified portfolio that is light on this corner of the market:

SPDR S&P Health Care Equipment ETF (XHE)

The relatively new fund in the space comes from State Street and its XHE. The fund tracks the health care equipment and supplies sector of the S&P total market index, utilizing a modified equal weight methodology for construction of the portfolio. The fund charges investors 35 basis points a year in fees and holds 56 securities in total. Unfortunately, it has not gained a ton in assets yet, having amassed just $24.4 million in AUM since its launch a little over a year ago (see Is The Shipping ETF About To Hit An Iceberg?).

In terms of holdings, Zoll Medical (ZOLL), Mako Surgical (MAKO), and Volcano Corp (VOLC) take the top three spots, although the equal weighting scheme ensures that no one company dominates the index. For style, growth firms dominate the product, comprising about 65% of the product while value firms make up just 16% of the fund. Unsurprisingly given this focus, large caps aren’t exactly a big chunk of assets, making up less than 20% of total assets, less than the total given to micro caps (24%).

Dow Jones U.S. Medical Device Index Fund (IHI)

For the original fund in the space, investors should look no further than iShares’ IHI. The fund tracks the Dow Jones U.S. Select Medical Equipment Index which is a broad market cap benchmark tracking the sector. The index provider deems this to include firms that manufacture and distribute medical devices such as MRI scanners, prosthetics, pacemakers, X-ray machines and other non-disposable medical devices. The fund holds 39 securities in total and charges investors 47 basis points a year in fees, although it does have over $350 million in assets, suggesting pretty tight bid ask spreads (read Time To Buy The Media ETFs).

This fund is more concentrated than its counterpart, putting nearly two-fifths of its assets in the top ten holdings. The top three spots include Medtronic (MDT), Covidien (COV), and Thermo Fisher Scientific (TMO), which combine to make up nearly 26.6% of total assets. Thanks to this heavier concentration and market cap weighting, the fund also has more of a tilt towards large cap securities, as 50% of the fund is in large cap stocks. Additionally, growth stocks make up about 50% of the fund while blend stocks account for 30% as well, implying a more balanced approach in terms of styles for this popular ETF.

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