Healthcare ETFs Could Be Emergency Care for Advisors

There may not be any stock market sector more two-faced for investors than healthcare.  

On one hand, these stocks represent businesses that literally change our lives, and keep doing it with great effectiveness and innovation.  

What started in ancient times with “bloodletting” and then discovery of medications like penicillin, has blossomed into a modern industry with cutting-edge technologies to keep us well or get us better. Heart surgery, athletic performance and prevention of disease are all miles beyond where they used to be, thanks to the success of a wide range of healthcare businesses.  

In particular, the biotechnology industry has gone from having a reputation of being a bunch of startups to a set of confirmed market leaders. That has provided the other side of merger transactions for smaller companies that have shown potential but need a “big fish” to reach their potential. 

Yet with all those developments, the industry has had its issues. Medications that solve one problem but create others require commercials to spend most of their air time reading disclaimers instead of talking about what the drug does. Product recalls and other episodes that lead to massive court settlements affect earnings and reputations.  

Who truly loves the U.S. healthcare systems, where battling to get coverage and then being able to afford that coverage is a national issue. The folks in Washington D.C. can’t seem to resolve it to the public's satisfaction. 

Healthcare ETFs to Consider 

Healthcare is a necessity and an aggravation at the same time. But since the former requires patients to put up with the latter, healthcare stocks have been able to retain their reputation as relatively defensive stocks. And the inclusion of biotech, cutting-edge medical device firms and the emergence of digital healthcare and medical records management businesses fills this sector with opportunity well beyond the traditional setup of the sector decades ago. 

This means that advisors need to understand “just enough to be dangerous” which is an old expression but one that hopefully does not apply to medical care! In ETF parlance, that starts with the original healthcare sector ETF, the $41 billion Health Care Select Sector SPDR ETF (XLV), which debuted in late 1998. It owns the healthcare stocks in the S&P 500, so naturally has a strong large cap tilt.  

XLV’s top 10 holdings currently compose 57% of the ETF’s assets, which puts investors in the same situation as most other sector “spider” ETFs. On the one hand, that excludes most other stocks from having much impact, individually or collectively. However, for investors who look at ETFs to fill pieces of a portfolio puzzle (alliteration intended), that concentration at the top makes it easier to know what you own. For some investors (myself included), one of the best things about ETFs is that they reduce single-stock risk but in cases like XLV, do not over-diversify.  

Taking that concept a step further, ETFs exist to take that same focused approach, but to segments of the healthcare sector. For instance, the $780 million iShares US Healthcare Providers ETF (IHF) has passed the 18-year mark, and while its portfolio contains 70 stocks, 74% are in the top 10 names. And the $5.1 billion iShares US Medical Devices ETF (IHI) has 71% allocated to its top 10 stocks, among 55 it owns in total. Still, these ETFs have the potential to surgically focus beyond the broader healthcare sector. 

Then, there are niche funds that aim to tap into the emergence of new healthcare approaches. Those funds, such as the $116 million ALPS Medical Breakthroughs ETF (SBIO), are less well-known but own more than 100 stocks. 

Diverse Healthcare Sector 

ETFs like this one provide investors and advisors with more of a private equity type of feel. That’s because the stocks are much smaller and while some may not work out well for shareholders, it only takes a few big ones to produce strong returns in this space. That’s what history has shown us. 

If you have your health, you have everything. If you are an advisor or a self-directed investor, your portfolio’s health may not be complete with examining the now-diverse healthcare ETF sector.