Equity: U.S. Pharmaceuticals
US pharmaceutical ETFs have performed well over the past few years as yield-hungry investors piled into mega-cap pharma companies paying handsome dividends, and expected benefits from an
“IHE provides the most broad-based exposure to the largest pharma companies” aging population in the US and growth overseas. Understandably, pharma ETFs have garnered much attention.
The segment was long dominated by the Pharmaceutical HOLDRS (PPH), formerly a $1B US-centric fund. However, PPH transitioned over to Van Eck Securities in December 2011; it's now the Market Vectors Pharmaceutical ETF. Post-transition, PPH is a very different fund, and was moved into the global pharmaceuticals segment.
The US pharma segment now offers three interesting funds, each with a unique selection and weighting strategy: the SPDR S&P Pharmaceuticals ETF (XPH), the iShares Dow Jones U.S. Pharmaceuticals Fund (IHE) and the PowerShares Dynamic Pharmaceuticals Portfolio (PJP). IHE provides the most broad-based exposure to the largest pharma companies by market cap, and is our analyst pick for the segment. XPH equal-weights its 35 holdings, while PJP uses a quant-driven methodology to select and weight companies based on fundamental and risk factors.
All three funds have heavier mid- and small-cap tilts compared to a neutral market-based view of the industry. Pharma is dominated by just three mega-caps: J&J, Pfizer and Merck. Combined, they make up close to half the industry's total market cap. XPH tilts smallest, with a weighted average market cap of roughly ¼ our benchmark's. XPH is also the cheapest in the segment, charging 0.35%. Investors pay more for PJPs attempts to beat the industry—it's the most expensive fund, charging 0.63% annually. (Insight updated 11/22/17)
ETF.com Efficiency Insight
XPH is the cheapest fund in the segment, costing investors 0.35% annually. XPH is trailed by IHE's 0.45% expense ratio, and finally, the big-ticket item, PJP. PJP charges a whopping
“XPH is the cheapest fund in the segment, costing investors 0.35% annually.” 0.63% for its multi-factor methodology.
PJP also tracks its index poorly, sometimes trailing it by 1% or more over a rolling 12 month period—this may be partially due to its quant-driven model that holds an assortment of mid- and small-cap companies that may be harder to trade. IHE tracks decently, though with less consistency than we'd like. XPH is the standout in tracking here, consistently trailing by about its cost.
For tax-conscious investors, IHE and PJP are the winners—they haven’t paid out any capital gains since their inceptions in 2006 and 2005, respectively. XPH, on the other hand, has paid out capital gains distributions in five of the past eight years.
Despite their differences in costs and tracking errors, all three funds are well-established, in that they have sufficient assets under management and carry low fund-closure risk. Efficiency is not likely to be the sole deciding factor in choosing among these funds. (Insight updated 11/22/17)
ETF.com Tradability Insight
PJP leads the pack in Tradability, with IHE and XPH falling not far behind. All three funds have sufficient onscreen liquidity, with median daily volumes ranging between $5M and $15M. All
“PJP leads the pack in Tradability, with IHE and XPH falling closely behind” three funds have mediocre underlying volume, which means that trading in bulk may move the market. The three funds have decent spreads that average 0.06% to 0.09%, but these spreads widen periodically, so using limit orders is still recommended. (Insight updated 11/22/17)
ETF.com Fit Insight
None of the funds scores especially well in Fit due to their differences from the broader industry, but that's not necessarily a bad thing. Indeed, one could argue that with three
“IHE's diversity provides more exposure to generic drug makers and biotech firms.” firms making up more than half the industry, some form of tilt might be a better, or at least less risky, play.
IHE provides the most comprehensive exposure by holding 40 of the largest pharma companies. The fund is cap-weighted, but less concentrated than our benchmark because it caps the weighting on mega-caps. It also tilts smaller, with a weighted average market cap of roughly half the industry's. IHE's greater diversity also provides more exposure to generic drug makers and biotech firms.
XPH and PJP have even smaller weighted average market caps than IHE, with XPH the smallest at roughly ¼ the industry average. XPH significantly skews from our benchmark because of its equal-weighted structure. Its combined mid-, small- and micro-cap exposure is nearly 2/3 of the portfolio—volatility-shy investors should look elsewhere. PJP uses a quant-driven methodology to select and weight pharma companies based on several fundamental and risk factors. While household mega-caps still dominate its top holdings, PJP has significant exposure to the biotech sector and includes Gilead and Amgen (excluded in other pharma ETFs) in its top three holdings.
Formerly, PPH had the closest Fit to the industry. However, the newly transitioned fund is a part of the global pharma segment because it now includes US-listed foreign players such as Novartis, AstraZeneca and GlaxoSmithKline. (Insight updated 11/22/17)