Eric Dutram: The healthcare sector is considered to be a safe haven in times of economic uncertainty as its goods and services are in demand no matter what the broader conditions are. Thanks to this and some recent positive trends in the space, investors have once more begun to take another look at this intriguing slice of the market (Forget Big Pharma, It Is Time For A Biotech ETF).
Still, even though a major point of uncertainty—the Affordable Care Act—appears to finally be going through—the space is by no means out of the woods yet. Competition is broadly increasing in the sector thanks to generics in the pharma space.
Additionally, many companies in the sector are approaching the end of their patent time periods, putting further pressure on the long-term growth of the sector. Generic competition and insufficient new product sales are not the only factors impacting performance in 2012.
Other headwinds include EU and Japan pricing pressure as well as negative currency movement. In fact, results of several companies including Johnson & Johnson (JNJ) were hit by negative currency movement in the summer quarter.
Meanwhile, the U.S. government is exploring options which will help increase the availability of generics. The Obama administration announced that it is looking to implement a proposal under which the exclusivity period for branded drugs will be cut down by 5 years, thereby allowing generics to enter the market sooner. (Could The Small Cap Healthcare ETF Be A Great Pick?).
This has worked well for a few firms, helping them to hold steady in the current market environment, but it has forced many to look at M&A activity to boost growth instead. This has been a boon for small caps as these have become takeover targets in this environment as large caps grow more desperate to fill up their pipelines or acquire new technologies.
Given this, a look at a top ranked small cap ETF in the space could be the way to target the best of the segment with lower levels of risk (Top Zacks Ranked Pharma ETF in Focus)
About the Zacks ETF Rank
This can easily be done by using the Zacks ETF Rank. This technique provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.
The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.
Using this strategy, we have found an ETF Ranked 1 or ‘Strong Buy’ in the healthcare industry which we have highlighted in greater detail below:
PowerShares S&P Small Cap Health Care ETF (NASDAQ:PSCH)
PSCH tracks the S&P SmallCap 600 Capped Health Care Index. The Index has been specifically designed to track small companies which are mainly into providing healthcare-related products, biotechnology, pharmaceuticals, medical technology, supplies, and facilities (Medical Device ETFs: A Better Way To Play Health Care?). This produces a product which is home to 66 stocks while charging investors a somewhat low fee of 29 basis points.
As the name suggests, the fund has a tilt towards small cap securities thereby assigning more than 55% of the asset base to it while the rest goes to micro caps which have a share of 45% in the asset base. A look at the style pattern reveals that the fund has a preference for growth stock thereby allocating more than 60% of the asset base while value securities have a share of just 14%.
This also implies that the fund prioritises securities on the basis of earnings growth and tends to have little inclination for undervalued stocks or stocks which trade below their intrinsic value.
With that being said, investors should note that the product is relatively well spread out from an industry perspective holding relatively equal portions of companies in the medical equipment, services, pharma, and biotech spaces (read ETFs That Will Haunt Your Portfolio If You Don’t Buy Them).
Among individual holdings as well, the fund’s allocation does not appear to be concentrated in the top 10 holdings. In fact, the fund assigns just 36% of its asset base to the top 10 holdings while the rest is spread out among other companies. Top individual holdings include Cubist Pharmaceuticals, Align Technology Inc, and Heamonetics Corp, while these three account for about 14% of the total
Overall, this fund could be far more volatile than others in the space while paying less in dividends as well. However, the growth is hard to deny for the segment and big pharma is likely to get even more desperate and competitive. As a result, the risks seem to be worth taking in this ETF and those who are looking for more exposure to this segment could have a winner on their hands with this small cap fund.
In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.