Eric Dutram: With the Healthcare sector being one of the most defensive sectors in the U.S. market, it has attracted investors’ attention during this climate of global economic uncertainties. This has happened despite profitability remaining under pressure for companies from many corners of the sector, and some policy uncertainty with regards to the Affordable Care Act.
In fact the Healthcare Select Sector SPDR (NYSEARCA:XLV), an ETF which tracks the performance of all the Healthcare sector stocks from the S&P 500, is up almost 14.2% year to date lagging behind only Financial (NYSEARCA:XLF) and Consumer Discretionary (NYSEARCA:XLY).
Now with the Q3 earnings season behind us, health care has made a good case for a leadership role in this market, despite some worries over revenues in the long term. This comes as many health care firms focus in on a cliff of their own, a patent cliff, as many of their billion dollar drugs are fast approaching the end of their protection period and could soon face competition (read Complete Your Portfolio with These Three ETFs).
Still, going forward the space is a potential bright spot as the U.S. is one of the major markets for healthcare and one of the largest spenders on public health, putting the sector in an advantageous position.
Furthermore, the increase in market size coupled with the rapid inorganic growth for many companies in the form of mergers and acquisitions will help form a cordial coalition that would seek to make up for the decrease in revenue in the recent past, and address the issue for patent expiry for many of their key products.
This has probably already begun to take shape as is evident in the form of increase in revenues from the third quarter revenue numbers.
The defensive nature of stocks from the sector has also been a major advantage for them in this current turbulent market environment, and it has allowed a few firms to hold steady. Given this, a look at some of the top ranked ETFs in the space could be the way to target the best of the segment with lower levels of risk (see Target Allocation ETF Investing 101).
About the Zacks ETF Rank
A look at top ranked Healthcare ETFs can 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, a Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.
Using this strategy, we have found one ETF which is Ranked 1 or ‘Strong Buy’ with this, model in the Healthcare sector which we have highlighted in greater detail below:
First Trust Health Care AlphaDEX ETF (NYSEARCA:FXH)
Launched in May of 2007, First Trust Health Care AlphaDEX fund (FXH) is an exchange traded fund (ETF) designed to provide a broad exposure to the U.S. equity market with a core focus on the broader Healthcare sector.
The ETF tracks the StrataQuant Healthcare Index which employs an AlphaDEX stock selection methodology from the parent Russell 1000 index with a core focus on healthcare stocks. The AlphaDEX methodology of stock selection takes into account various growth and value factors in order to filter stocks from the broad index.
Thanks to this innovative fund management technique, FXH charges a hefty expense ratio of 70 basis points. However, the product has amassed an asset base of over $600 million while daily volume is relatively robust at about 150,000 shares a day (read Health Care ETFs in Focus on Obamacare Supreme Court Decision).
The ETF lays its bets mostly on the Healthcare service providers and Biotechnology industry. These two industries within the broader healthcare sector account for nearly 63% of its total assets while pharmaceuticals account for almost 12%.
From an individual holdings point of view, FXH has 70 securities in its basket and does well in minimizing concentration risk by allocating just around 23% of its total assets in the top 10 companies.
FXH has returned a solid 18% YTD, outperforming the broad markets and XLV over the time frame. This can be best explained by the fact that the healthcare sector, due to its defensive nature, has provided a safe haven for investors, while the fund’s AlphaDEX methodology has helped to select the best stocks of the group.
Still on a one year look, the fund is holding up even better with a gain of over 21% in the trailing 52 week period, suggesting decent long term performance as well.
Over the past three years, the ETF has had low historic volatility as measured by its annualized standard deviation of just 18.65%. This is reflected in our outlook for the product as we maintain a ‘Low’ risk outlook along with a Zacks ETF Rank of 1 or ‘Strong Buy’ For this intriguing healthcare ETF.
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.