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Play Surging Health Care with These Small Cap ETFs

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The healthcare space has led the broad market for most of the first half of 2013 and continues its incredible run into the second half as well (read: Top ETFs of the First Half of the Year). In fact, the SPDR Health Care Select Sector Fund (XLV - Free Report) is up nearly 24.9% in the year-to-date timeframe compared to 17.0% gains for SPDR S&P 500 (SPY).

This is largely thanks to some sector rotation along with strength in biotechnology and the pharmaceuticals firms. Investors of late have been moving out of lower risk, high dividend sectors like utilities and real estate investment trusts, into higher risk, growth sectors like financials, consumer discretionary and healthcare.

The healthcare space will likely be a bright spot going forward 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.

The sector is poised to benefit from the aging population, higher rates of chronic disease, growing demand in emerging markets, product launches and increased mergers & acquisitions. Further, the sector also looks well positioned to profit from the imminent Affordable Care Act (also known as Obamacare) (read: 2 Great Healthcare ETFs in Focus).

Why Small Caps?

Investors are losing faith in the international economy with challenges to emerge from recession becoming tougher. Many emerging markets, including China, are also experiencing slowdown.

As a result, investors seeking to take real advantage of the growing healthcare space should focus in on small caps rather than the large caps. This is because small caps have more potential to move higher given their true domestic exposure (read: Time to Focus on Small Cap ETFs?).

These pint sized stocks aren’t big enough to be international behemoths, so these focus mostly on the U.S. for their revenues, thereby promising returns in a global slowdown. Furthermore, given their small sizes, these have a much easier time growing than their already tapped out large cap counterparts.

While small caps are often capable of higher levels of growth than large caps, these can experience levels of volatility as huge gains and losses can occur in a very short period of time. In this backdrop, we have highlighted three small cap ETFs that have generated impressive returns so far this year.

Any of the following three could be rewarding for investors with a more domestic focus in the second half of the year (see more in the Zacks ETF Center).

SPDR S&P Biotech ETF (XBI - Free Report)

This is by far the most popular choice in the biotech corner of the healthcare segment. The fund tracks the S&P Biotechnology Select Industry Index (read: Biotechnology ETF Investing 101). The product has $926.9 million in AUM and trades more than a quarter million in volume a day, while its cost is just 35 basis points a year.

XBI is an equal weighted ETF, spreading out assets across roughly 57 firms. No single company accounts for more than 2.93% of the portfolio. The fund allocates half of the assets in small cap securities while large cap takes just 14% share.

In terms of performance, the product generated more than 27% returns year-to-date and 21% in the trailing one-year period.

PowerShares S&P SmallCap Health Care Portfolio (PSCH - Free Report) )

This ETF tracks the S&P SmallCap 600 Capped Health Care Index and holds 66 securities in its basket. It is unpopular having amassed $119.6 million in asset base and trading in volume of less than 15,000 shares per day, while charging a relatively low 29 bps a year in fees.

From a securities look, the product is somewhat concentrated across each security as the top three holdings – Salix Pharmaceuticals, Cubist Pharmaceuticals and Centene Corp. – together make up for 14.5% share in the basket. PSCH is a small cap centric fund accounting for at least 85% of the assets.

Additionally, the fund is relatively well spread out from an industry perspective holding relatively equal portions of companies in the medical equipment, services, pharma, and biotech spaces. The ETF is up about 26.22% so far this year and 22.33% in the trailing one-year period.

PowerShares Dynamic Biotechnology & Genome Portfolio (PBE - Free Report) )

This ETF follows the Dynamic Biotechnology & Genome Intellidex Index. The product has a somewhat sparse volume of just 18,000 shares a day, but a decent level of assets under management of about $170 million. The fund charges 63 bps in fees and expenses from investors.

With holdings of 30 stocks, the fund is moderately concentrated in the top 10 holdings and focuses more on small caps with 41% of total assets. Large caps account for 23% while the rest goes towards mid caps. Waters Corp, Illumina and Life Technologies occupy the top three spots in the basket with a combined share of nearly 15%.

In terms of industrial exposure, 61% of assets are allocated to biotechnology while 29% are alloted pharmaceuticals (read: 3 Impressive Biotech ETFs Crushing the Market). The product has added an impressive 35% year-to-date and over 30% in the trailing one-year period.

Bottom Line

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.

Thus, these products could be an interesting choice for investors seeking higher returns from the space.

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