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Healthcare ETFs for your Portfolio's Wellness

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Healthcare sector is the best performer among all S&P sectors this year with an impressive 19.0% return, compared with about 9.6% for the broader market. This comes after a stellar performance in 2013, when the sector gained 41.2%.
 
Despite these impressive gains, there are many reasons to be positive on this sector in the longer term. First and foremost, this sector is a direct beneficiary of the world’s rapidly aging demographic trend. (Read: Best ETF Strategies for the fourth quarter)
 
Global population is growing older at an unprecedented rate. The number of persons aged 60 years or more worldwide is expected to increase from 841 million in 2013 to more than 2 billion by 2050 and their share will almost double from 11.7% to 21.1% during this time period, according to the UN’s “World Population Ageing” report.
 
While most developed countries already have relatively aged population, older population in developing nations is now growing faster than in the developed ones. With rapid urbanization in emerging markets, pollution and stress have been on the rise, resulting in proliferation of ailments. These unwelcome trends will keep healthcare spending on the rise.
 
Further, in many developing countries, governments are increasing their healthcare support. And in these countries, healthcare spending is rising from a very low level and has a significant potential to go up as income levels in these countries rise.
 
The Affordable Care Act—popularly known as ObamaCare--has expanded healthcare coverage to millions of Americans without insurance. With expanded coverage, many healthcare companies particularly pharma companies and managed care providers will be long-term beneficiaries.
 
Analysts are still positive on the sector; per S&P, the sector is expected to deliver double-digit EPS growth in Q3 and Q4—11.1% and 21.4% respectively. Also, being non-cyclical in nature healthcare sector provides a defensive tilt to the portfolio. In the current market environment--when concerns about weak global growth, geopolitical risks and stretched stock market valuations--have been rising, it makes sense to increase exposure to defensive stocks and ETFs. (Read: 3 ways to outperform the market with quality ETFs)
 
With rapid growth, large healthcare companies have gathered enormous amounts of cash on their balance sheets—a large proportion of which is lying overseas. Many of these companies were seeking to acquire foreign companies and move their tax domiciles to locations more tax favorable than the US.
 
The announcement of new rules intended to curb tax inversion did lead to a sell-off in shares of some of the European companies that were being perceived as potential targets. However, many analysts believe that despite new rules, some of the benefits of inversion were still available. Further, merger proposals that were not totally motivated by tax benefits and made some business sense are still likely to move forward.
 
Risks
 
Large companies within this sector, particularly giant pharma companies have global operations and may face currency headwinds in the short-term as the US dollar has been quite bullish in the last few months. Sluggish economic conditions in Europe are already posing challenges to companies with large operations in that region. Also, healthcare sector is more prone to regulatory risks than many other sectors. (Read: Focus on stocks with strong dividend growth with these 5 ETFs)
 
PowerShares Dynamic Pharmaceuticals Portfolio (PJP - Free Report)

Within the broader healthcare space, I like pharmaceutical ETFs in particular. Pharma firms are generally less volatile than others in this space and should also benefit from improving pipelines and cost-cutting measures taken in recent years.

PJP’s holdings are selected on the basis of a variety of investment merit criteria, including price momentum, earnings momentum, quality, management action, and value.
 
Well known pharma companies like J&J, Merck and Pfizer are among its top holdings. These companies derive a significant proportion of their revenue from international markets and stand to profit from aging population and rising incomes in these markets.

With its expense ratio of 63 basis points (due to enhanced indexing methodology), this ETF is slightly expensive but it has justified its higher cost with significant outperformance compared to its peers.

Vanguard Health Care ETF (VHT - Free Report)
 
With an expense ratio of just 14 basis pints, VHT is the cheapest way of getting a diversified exposure to well-known healthcare stocks. The fund has a tilt towards pharma stocks with almost 39% weight, with biotech (22%) and healthcare equipments (15%) rounding out the top three industries.

Like PJP, its top three holdings are J&J, Merck and Pfizer, with J&P itself accosting for one-tenth of the asset base. Being market-cap weighted, the fund is top heavy with top 10% of holdings account for 46% of assets, even though it holds more than 300 stocks.


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