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Is This Low Risk Pharma ETF a Great Pick?

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In the recent past, the pharmaceutical industry has been facing serious headwinds as lack of new products coupled with shorter product pipelines continue to malign the outlook for many firms from the industry. Furthermore, the industry is approaching a huge patent cliff as many of the billion dollar drugs are fast approaching the end of their protection periods.

Also, the industry has been facing stiff competition from its generic counterparts. Amidst all this, is the support of the Obama administration for generics. The administration seeks to implement a proposal to reduce entry barriers for generics leading to the industry being more competitive. However, it will certainly not help the cause of many firms hanging on to their limited amount of on-patent drugs (read Uncertain about the Economy? Try Market Neutral ETFs).

After all, the U.S is one of the major markets for healthcare and one of the largest spenders on public health which is an added advantage for the industry. Additionally, the increase in market size coupled with the rapid inorganic growth for many companies in the form of mergers and acquisitions will help to fill up the product pipeline which can help to make up for the slide in revenues and address concerns in the near term.

Lastly, the defensive nature of stocks from the industry has been a major advantage for them in this current market environment, and it has allowed a few firms to hold steady. Given this, a look at some of the top ranked ETFs in the space could be the way to target the best of the segment with lower levels of risk (see Target Allocation ETF Investing 101).

About the Zacks ETF Rank

A look at top ranked Pharmaceutical ETFs can be done by using the Zacks ETF Rank. This technique provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, a Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.

Using this strategy, we have found a ETF which is Ranked 1 or ‘Strong Buy’ in the pharmaceutical industry which we have highlighted in greater detail below:

iShares Dow Jones US Pharmaceuticals ETF (IHE)

Launched in May of 2006, iShares Dow Jones US Pharmaceuticals Fund (IHE - Free Report) is an exchange traded fund (ETF) designed to provide a broad exposure to the U.S. equity market with a core focus on the pharmaceutical segment of the Healthcare sector.

IHE tracks the Dow Jones U.S. Select Pharmaceuticals Index before fees and expenses. The index includes stocks of all pharmaceutical companies except the vitamin producing firms (read Health Care ETFs in Focus on Obamacare Supreme Court Decision).

This ETF is appropriate for investors seeking broad exposure to the pharmaceutical segment of the U.S. Healthcare sector. IHE provides a targeted bet on one of the most defensive sectors in the U.S. market which has attracted investors’ attention and confidence amidst global economic uncertainties and despite reduced margins of companies from the sector. It charges an expense ratio of 0.47%.

IHE has a narrow investment theme as it only tracks stocks from the pharmaceutical industry of the broader Healthcare sector. From an individual holdings point of view, it holds 37 securities in its basket and allocates around 61% of its total assets in the top 10 companies.

Heavyweights like Pfizer Inc, (9.50%), Johnson & Johnson (9.32%), Merck and Co. (8.36%) and Abbott Laboratories (7.54%) are among its top holdings (see more in the Zacks ETF Center).

IHE has returned an impressive 18.86% YTD (as on 30th September 2012), slightly outperforming the broad markets over the time frame. This can be best explained by the fact that the healthcare sector due to its defensive nature has provided a safe haven for investors at a period when the equity markets were witnessing massive sell-offs.

Still on a one year look, the fund is holding up even better with a gain of over 35% in the trailing 52 weeks as on 30th September 2012. (read 4 International ETFs Yielding more than 5%).

Over the past three years the ETF has had low historic volatility as measured by its annualized standard deviation of just 17%. This is also reflected in our outlook for the product as we maintain a ‘Low’ risk outlook along with a Zacks ETF Rank of 1 or ‘Strong Buy.’

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