Health care sector ETFs offer a port in the storm

In contrast to the 2000-2003 bear market that left small-cap and value ETFs relatively unscathed, the present bear market has left equity investors with almost no place to hide. And with the Standard & Poor’s 500 stock index almost 50% below its October 2007 peak, it is far from certain that the danger has passed for stocks. Even though moving some of your clients’ assets into safe bond investments or into cash would be a good defensive move while you wait for the market to sort itself out, many advisers are reluctant to abandon stocks altogether and are looking for a relatively quiet spot within the equity markets. Health care exchange traded funds is such an area. Traditionally, health care has been viewed as a defensive sector, meaning that health care sector stocks have held up better than the overall stock market during major bear markets. The current bear market is no exception. Regardless of what the market is doing, people tend to maintain their health care spending, and profits in the sector hold. Because senior citizens account for a disproportionate share of health care expenses, Medicare guarantees a flow of revenue to the health care industry. There are literally dozens of health care ETFs, and not all are created equal. The first group to be aware of is the broad U.S. health care sector ETFs: Health Care Sector SPDR (XLV) from State Street Global Advisors of Boston, iShares Dow Jones U.S. Healthcare Sector Index ETF (IYH) from Barclays Global Fund Advisors in San Francisco, a subsidiary of Barclays Global Investors of Jersey City, N.J., and the Vanguard Health Care ETF (VHT) from The Vanguard Group Inc. of Malvern, Pa. The investment performance of these ETFs has been similar over the past three and five years, with the Health Care Sector SPDR just a bit weaker than the others. On the other hand, the Health Care SPDR is the most heavily traded of the three broad health care ETFs, so if you are looking to move more than 1,000 shares at a time, there is a potential advantage to using the Health Care Sector SPDR, especially if you are an active trader. All three of these broad sector ETFs have the same principal holdings: large pharmaceutical and equipment companies such as Johnson and Johnson, Pfizer Inc., Abbott Laboratories, Merck & Co. Inc. and Amgen Inc. However, the Vanguard Health Care ETF does not hold the same portfolio as the well-regarded Vanguard Health Care Fund (VGHCX) which, unlike the ETF, has a minimum holding period of one year. Biotechnology ETFs Biotechnology companies have a more specific niche than the broad-based companies. They are concerned with developing therapies, rather than with maintaining large sales forces. In general, the companies in biotechnology ETFs are smaller than those in broad health care ETFs, and biotechnology ETFs differ from each other more than their broad counterparts do. During the current bear market, most biotechnology ETFs have held up better than the broad health care sector, and certainly better than the S&P 500 stock index. But biotech stocks as a group have not proven themselves to be defensive like the broad health care companies. In the 2000-2003 downturn, biotechnology ETFs and mutual funds suffered losses commensurate with other technology companies, which means that they lost far more than the overall stock market. As a result, you should view biotechnology ETFs as a vehicle for trading or tactical asset allocation rather than for buying and holding during all market environments. Biotech ETFs include Biotech HOLDRS (BBH) from Merrill Lynch & Co. Inc. of New York, iShares Nasdaq Biotechnology Index ETF (IBB), SPDR S&P Biotech ETF (XBI), and Powershares Dynamic Biotech and Genome Portfolio (PBE) from Invesco PowerShares Capital Management LLC in Wheaton, Ill. The Biotech HOLDRS has clearly performed best, but its future performance remains uncertain. The portfolio was fixed at inception and over the years has become concentrated in just four stocks, with Genentech Inc. of San Francisco comprising half the portfolio. With F. Hoffmann-La Roche Ltd. of Basel, Switzerland, buying Genentech, the quality of the Biotech HOLDRS portfolio may change significantly. Also, you can only buy or sell HOLDRS in lots of 100 shares. Biotechnology ETFs have performed very differently from one another, so you need to exercise care in selecting the one to use. Even though Biotech HOLDRS has performed the best, the uncertainty regarding the fate of its predominant holding suggests that the SPDR S&P Biotech ETF appears to offer the best balance between risk and reward in the group. Health care is a sector that has held up better than the broad market in the past two years, and it has good prospects based on the aging of the baby boomer cohort in the United States. If you want to buy a broad U.S. health care ETF, you should probably use the Health Care Sector SPDR, since it is the most liquid.