Healthcare Uncertainty Opens Window for ETF Investors

While the U.S. Supreme Court is creating fresh uncertainty over the future of healthcare, ETFs are seeing good returns in most industry subsectors.


At first glance, a general malaise seems to have fallen over healthcare investments thanks largely to uncertainty over how the national healthcare reform law will be implemented. With the U.S. Supreme Court reviewing the constitutionality of a major component of the reform, investors appear to be staying on the sidelines.

In reality, one industry subindustry — pharmaceuticals — is dragging down overall returns, says Jeffrey Loo, an analyst for S&P’s Capital IQ. That one subindustry is up by only 2.8 percent so far this year (as of April 5), due mostly to the industry’s failure to produce new drugs. Loo says. Despite increasing R&D every year, pharma companies seem unable to turn out new blockbusters. And existing ones continue to move out of patent protection. Without pharmaceuticals, the sector’s return would be considerably higher than the 8.8 percent it has produced so far this year, Loo says. And that’s reflected in a number of ETFs that invest in them, he adds.

“There are 10 subindustries under health care, and 9 out of 10 are doing better than the overall sector,” says Loo.

Life sciences, tools and services are a case in point. With a gain of 23.1 percent so far this year, the index reflecting that subindustry outperformed the overall sector by more than four times. The top performers in this group, which includes medical devices, were Agilent Technologies (A), ICON PLC (ICLR), Life Technologies (LIFE), Perkinelmer (PKI), Thermo Fisher Scientific (TMO) and Waters Corp. (WAT). Four of these six companies are in the top ten holdings of the Guggenheim S&P 500 Equal Weight Health Care ETF (RYH), which is up 13.41 percent during the past 12 months, and 25.58 percent for the past three years. Loo credits an easing of funding worries over the National Institutes of Health budget, which funds government and academic research facilities that are big customers of the component companies. Of RYH’s top five subindustry equity holdings, the life sciences subindustry comprises 11.09 percent, with the largest component health care equipment at 25.44 percent.

For similar reasons Loo also likes this fund’s peers: Health Care Select Sector SPDR Fund (XLV), iShares Dow Jones U.S. Healthcare Sector Index Fund (IYH) and Vanguard Health Care Index Fund: ETF Shares (VHT). XLV has a one-year return of 12.45 percent, compared to 11.25 percent for IYH and 10.57 percent for VHT.

The biotech subindustry is also far outperforming the sector, with a return so far this year of 12.1 percent.

Of course, drilling down to these levels increases risks, Loo concedes. Life sciences declined last year by 14.7 percent. But at the moment at least, its fundamentals seem positive, as the industry is embracing new technology to pick up the pace of research into genes and new surgical techniques. Sunnyvale, California–based Intuitive Surgical, makers of a system for robot-assisted surgery, has soared to $529 a share and is one of the top four holdings in the iShares Dow Jones U.S. Medical Fund (IHI), which tracks the Dow Jones U.S. Select Medical Equipment index and is held by seven other ETFs.

All told, there are 20 healthcare-related ETFs. About a dozen are subindustry ETFs.