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Are Healthcare ETFs a Good Value?

Are Healthcare ETFs a Good Value?
By Ron DeLegge, Editor
January 20, 2009

SAN DIEGO (ETFguide.com) Ė Hey, psst! In case no oneís told you, healthcare stocks are on sale.

Despite their defensive nature, healthcare stocks have been hospitalized, falling around 24% on average over the past 52-weeks. As a result, the decline has created attractive valuations within the sector causing some investors to snap up healthcare shares. 

Top mutual fund managers like Bruce Berkowitz and his Fairholme Fund (Nasdaq: FAIRX) have been overweighting healthcare stocks. Berkowitzís fund has a whopping 38.13% exposure to the healthcare sector with Pfizer, Unitedhealth Group, and WellPoint each being among the $7.25 billion fundís top ten holdings. 

 
Below is an excerpt from the ETF Profit Strategy Newsletter Ė Published on Oct.21, 2008
At the time, the Dow was above 9,000. It dropped below 7,500 and rallied into Nov./Dec

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Short-Term: published on Oct. 21, 2008
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According to New York-based AltaVista Research, healthcare stocks based upon 2009 earnings estimates are currently trading at a P/E ratio of 10.9, which is a discount to the S&P 500ís 11.9 multiple.

What are some of the major ETFs that follow the healthcare sector?

Hereís a short list of five healthcare ETFs:

iShares Dow Jones U.S. Healthcare Sector Index Fund (NYSEArca: IYH)

The Dow Jones index behind this particular ETF follows contains market exposure to 139 healthcare stocks. Companies within the index are selected passively and weighted according to their market capitalization or size. The median market size of healthcare stocks within IYH is just over $2 billion.

In 2008, IYH declined by 23.10% compared to a 38% fall in the S&P 500 (AMEX: SPY) and Dow Jones (AMEX: DIA). Johnson & Johnson (NYSE: JNJ) with 12.62%, Pfizer (NYSE: PFE) with 9.27%, and Abbot Laboratories (NYSE: ABT) with 6.04% represent the fundís three largest holdings in order. IYHís annual expense ratio is currently 0.48%.

Health Care Select Sector SPDR (NYSEArca: XLV)

This ETF follows healthcare stocks within the S&P 500. This particular industry sector covers stocks of companies involved in health care equipment and supplies, health care providers and services, biotechnology, and pharmaceuticals makers. The healthcare industry accounts for 15.35% of the S&P 500ís overall sector weighting, making it the second largest sector within the index just behind technology. With just over $2 billion in assets, XLV is the largest healthcare ETF.

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In 2008, XLV declined by 23.15% compared to a 38.49% fall in the S&P 500. Johnson & Johnson (14%), Pfizer (10.36%), and Abbot Laboratories (5.77%) represent the fundís three largest holdings in order. XLVís annual expense ratio is currently 0.23%, but thereís good news for ETF investors. XLVís annual expenses are being cut to 0.21% beginning 1/31/09.

Vanguard Healthcare ETF (NYSEArca: VHT)

The Vanguard ETF follows the MSCI US Investable Market Health Care Index. This particular healthcare ETF is the most diversified among similar offerings and currently has 297 stocks. The median market size of healthcare stocks within VHT is $45.8 billion.

In 2008, VHT declined by 23.48% compared to a 38.49% fall in the S&P 500. Johnson & Johnson (12.10%), Pfizer (8.60%), and Abbot Laboratories (5.90%) represent the fundís three largest holdings in order. VHTís annual expense ratio is 0.25%.

Rydex S&P Equal Weight Health Care ETF (NYSEArca: RYH)

This ETF shadows healthcare stocks within the S&P 500, but with a twist. Instead of weighting the companies by their market capitalization or size, it weights each stock equally. The net effect of equal weighting a stock index is a bias towards mid and small company stocks.

In 2008, RYH declined by 26.66% compared to a 38.49% fall in the S&P 500. Each one of the 54 stocks within RYH receives an equal weighting and the underlying index is rebalanced every quarter. RYHís annual expense ratio is 0.50%.

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PowerShares Dynamic Healthcare Sector Portfolio (NYSEArca: PTH)

This PowerShares Healthcare ETF is more of a portfolio strategy than a market index based strategy. Put another way, PTH isnít just attempting to match the performance of major healthcare equity benchmarks, itís trying to outperform them. Stocks within this ETF are selected using a secretive quantitative formula that screen for factors like fundamental growth and valuation.

In 2008, PTH declined by 34.89% compared to a 38.49% fall in the S&P 500. Each one of the 60 stocks within PTH receives a modified equal weighting and the underlying index is rebalanced every quarter. PTHís annual expense ratio is 0.70%.

Your Healthcare Strategy

While the Securities and Exchange Commission (SEC) regulates the registration of ETFs, it does not regulate the indexes behind them. For example, the SEC has a very loose definition of what an index is, what it does, or what it can be. For that reason, itís more important than ever to have a clear understanding of the exact investment strategy of your ETFs. (See the image of our Index Strategy Maps which illustrate the difference between how two healthcare ETFs are selecting and weighting stocks.)




As weíve covered, Healthcare ETFs are an excellent choice for value oriented ETF investors. Even though many of these funds have been dragged down by the marketís weak performance, healthcare is also a defensive sector. Itís a mistake conclude that all healthcare ETFs are the same.

Which healthcare ETFs are right for you? In the October issue of our ETF Profit Strategy Newsletter, we thoroughly analyzed the investment strategies of sector ETFs from each of the key ETF providers. Our next issue will include a detailed analysis of all major sector ETFs and their performance during bull and bear markets. Weíve done most of the legwork, now itís up to you to do the rest. Check it out.
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