[This article appears in our June 2019 issue of ETF Report.]
Health care has taken a beating this year, lagging the other sectors by significant margins.
That said, it remains a crucial component in an investor’s portfolio, and the choices to consider are vast, with many subsectors available, such as biotechnology and pharmaceuticals. However, looking at the large cap, broad-based, U.S.-focused funds, there are just nine to consider.
Costs can vary quite a bit, with the Fidelity MSCI Health Care Index ETF (FHLC) carrying an expense ratio of 0.08%, while the smart beta First Trust Health Care AlphaDEX Fund (FXH) comes with an expense ratio of 0.63%, almost eight times the price of its cheapest competitor (see Figure 1).
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How Many Holdings Matter
When it comes to components, the Invesco DWA Healthcare Momentum ETF (PTH) has the narrowest portfolio, with just 47 holdings, while the Vanguard Health Care ETF (VHT) has the broadest, at 359. The largest fund in the space, XLV, has the second smallest portfolio, with just 63 holdings, the same number held by the Invesco S&P 500 Equal Weight Health Care ETF (RYH).
The cap-weighted funds have very similar portfolios, and indeed, all include the same three companies as their top holdings in varying percentages: UnitedHealth, Johnson & Johnson and Pfizer. Except for JHMH, which has the same top three components as the cap-weighted funds in the group, the smart beta ETFs have very little overlap in their top holdings, so there’s a lot of differentiation in the portfolios there (see Figure 2).
XLV tops the flows for this group for the 12-month period ended April 30, 2019, with a gain of $1.8 billion, followed by VHT, which pulled in $1.4 billion. Of the cap-weighted funds, IYH had the smallest inflows, pulling in just $162.1 million.
FXH had the most inflows for the smart beta funds in the group, with a gain of $542.9 million. But BTEC had the only outflows among the group of nine ETFs, losing $0.4 million, and falling behind JHMH, which pulled in $9 million.
Of all the funds in the group, XLV has the longest history, dating back to a 1998 launch. Meanwhile, the Principal Healthcare Innovators Index ETF (BTEC) is the newest, with a launch date in August 2016 (see Figure 3).
When it comes to performance, there is significant variation, but over the long term, the end results appear to cluster very closely together. For example, year to date, the top performer is BTEC, with a return of 18.27%, while the worst performer is XLV, with a return of just 3.12%.
When it comes to the 10-year annualized returns, only six funds have a trading history that long, and the range is fairly tight: The top performer is FXH, with a return of 16.79%, but the bottom-ranked fund is XLV, with a return of 15.42%.
Given that the portfolios of the cap-weighted funds tend to be very similar, differing mainly in depth of coverage, it’s not surprising the returns are closely clustered. However, there’s a lot of variation in the returns of the smart beta funds, which often fall at the extreme ends of the spectrum. Returns tend to cluster closer together the longer the time period covered.
PTH, the momentum-based ETF in the space, perhaps offers the most interesting pattern of returns. It ranked dead last for the one-year period, with a return of -1.34%, but its three- and five-year annualized returns put it at the top of the rankings, returning 21.94% and 12.04%, respectively.
However, for the 10-year period, the annualized returns were decidedly middle of the pack. Given that the fund’s momentum strategy was only adopted in 2014, that could affect the results for the 10-year returns (see Figure 4).
Unsurprisingly, 12-month inflows were led by the largest fund in the group, XLV, which pulled in $1.8 billion, while VHT pulled in $1.4 billion. But in an interesting note, FXH, First Trust’s smart beta health care fund, was in third place for the period, with a gain of $542.9 million. Fourth and fifth place were claimed by FHLC and IYH, which pulled in $379.8 million and $162.1 million, respectively.
RYH, the sixth-largest fund, also had the sixth-highest level of inflows, pulling in $64.4 million, while PTH pulled in $30.2 million and JHMH gained $9 million. BTEC, however, was the only ETF in the group to lose money, with outflows of less than half a million.
Generally speaking, trading is going to be much easier for the cap-weighted funds, which tend to be larger and more liquid. XLV, the heavyweight in the group, has a spread of just 0.01% and a daily average dollar volume of $1.12 billion. FHLC is the smallest fund among the cap-weighted ETFs and the newest, so it’s not surprising that it’s the least liquid, with a spread of 0.04% and an average daily dollar volume of $9.76 million.
Among the smart beta funds in the group, BTEC is clearly the least liquid, with an average daily dollar volume of $74.39K and a spread of 0.27%. Meanwhile, FXH is the most liquid in that designation, with an average daily dollar volume of $29.35 million and an average spread of 0.05%.
As per usual, the SPDR Sector fund in this case is a decent vehicle for pretty much anyone, but especially for anyone looking to use it for tactical purposes. However, its narrow portfolio could give a buy-and-hold investor pause if they’re concerned about broad coverage.
For such investors, VHT is likely the better choice, as it has the broadest portfolio in the category and the second-lowest expense ratio: 0.10%. FHLC could also be appealing due to its almost equally broad portfolio and even lower cost. While it’s not a terribly large fund at $1.5 billion, it still has respectable assets and liquidity.
Among the smart beta ETFs, RYH and FXH are probably the most appealing. Both have fairly long trading histories. With regard to their portfolios, RYH has the exact same 63 holdings as XLV, but the top holdings are different due to its equal weighting approach.
FXH’s top holdings are also very different, with no overlap even in the top 10. Its portfolio owns a much smaller portion of pharmaceutical stocks, at roughly 16% of holdings versus the 43% weighting the industry receives in XLV. That alternate weighting approach is potentially very attractive to investors looking for outperformance relative to the generic market. However, remember that FXH is also the most expensive ETF in the group.