Finding Opportunity in Unloved Healthcare ETFs

Source: SectorSPDRs.com/VettaFi

Healthcare is a big, key economic sector - one of the top 3 sectors in the S&P 500, at about 12% of the index, behind only Information Technology and Financials.

Looking ahead, there are a few things to think about when it comes to the opportunity set in healthcare stocks (and ETFs):

Earnings season hasn’t been great for the sector, but it’s not all bad.

To quote FactSet’s sector earnings insights, “The Health Care sector is reporting the largest (year-over-year) earnings decline of all eleven sectors at -25.4%.” That said, healthcare was one of the top sectors with the highest percentages of companies reporting earnings above estimates. Additionally, it has revenues that beat expectations, according to FactSet. If you were to remove a company like Bristol Myers Squibb’s results from the overall sector, YOY earnings would still show a decline, but in the low single digits. Disparity abounds.

“At the industry level, 4 of the 5 industries in the sector are reporting (or have reported) a year-over-year decline in earnings. Two of these four industries reported a double-digit decrease: Pharmaceuticals (-54%) and Biotechnology (-41%). On the other hand, the Health Care Equipment & Supplies (6%) industry is the only industry reporting year-over-year growth in earnings,” FactSet reported.

The broad picture hasn't been rosy, but opportunities may exist for discerning investors looking for the gems among the rocks.

Different healthcare industries can offer opportunities that are easily accessible through ETFs.

A look at the performance of XLV’s underlying holdings is a perfect example of the disparity in results. About half of the fund’s 64 holdings are in the red this year. CVS Health leads losses with a 32% decline YTD. But on the flip side, there are names like Moderna, which are up 54% so far in 2024. Look at the top 10 holdings:

From an industry perspective, three industries are another example of three different results paths at the moment. Consider these segments, each represented by an ETF: SPDR S&P Health Care Equipment ETF (XHE) vs SPDR S&P Pharmaceuticals ETF (XPH) vs SPDR S&P Health Care Services ETF (XHS).

Recent momentum is a tailwind for equipment/devices. This is emerging as a shining spot in the otherwise weak earnings season this past quarter. It’s worth keeping an eye on this space.

Returns of XHE, XPH and XHS in various time frames show that industry leadership is not a given at any time:

Data: VettaFi PRO

Long term trends suggest potential upside for the sector.

Healthcare is a key economic sector and it’s currently oversold, cheap and unloved. But demographic trends support demand for healthcare going forward. Consider health spending as a metric, for example. The Centers for Medicare & Medicaid Services said in its latest National Health Expenditure Forecast that health spending growth should outpace GDP growth in years ahead.

“Over 2022-31 average National Health Expenditures (NHE) growth (5.4 percent) is projected to outpace that of average GDP growth (4.6 percent) resulting in an increase in the health spending share of Gross Domestic Product (GDP) from 18.3 percent in 2021 to 19.6 percent in 2031.”

In a recent commentary, Fidelity’s Edward Yoon called out the “long-term potential” of healthcare sector on the heels of what was a year marked by both performance disparity among healthcare companies and “excitement” about weight-loss drug innovation. Healthcare’s reputation as a defensive sector has weighed on its appeal at a time when we’ve been obsessed with growthy names, Yoon noted. But that could change going forward.

“This year, it’s impossible to predict what stocks or segments investors may favor. But the health care sector could have a strong setup, given recent low valuations combined with new products and long-term trends that may continue to play out,” Fidelity’s Yoon said. He highlighted developments in drug innovation and service trends in the health insurance industry.

Fidelity isn't alone on this call. There are plenty of market outlooks and strategist commentaries suggesting at least a market weight allocation to healthcare and a growing appetite for value plays, something that's supportive for the sector.

Many ETF Ways to Explore Healthcare

Healthcare stocks are a mixed bag this year, and ETF offer many types of access to the sector. Some high-level ideas include:

Take a market-cap weighted broad approach but know what you own:

XLV is the trader-favorite and posterchild for the sector tied to the S&P 500 Healthcare sector. But you can also look beyond the S&P 500 universe. The Fidelity MSCI Health Care Index ETF (FHLC), for instance, tracks the MSCI USA IMI Health Index while the Vanguard Health Care ETF (VHT) tracks the MSCI US IMI Health Care 25/50 Index.

Different benchmarks lead to different exposures. XLV has 64 holdings while VHT has more than 400 and FHLC is in the middle, so portfolio concentration varies significantly, and returns vary as well. Indexes matter, so get to know your benchmark.

Take a more granular industry focus:

State Street has the sector very well sliced and diced with ETFs such as XHE, XPH, XHS as well as SPDR S&P Biotech ETF (XBI) for biotech only. Other providers also have many ways to take a more focused approach to healthcare industries.

The Principal Healthcare Innovators ETF (BTEC), which focused on companies investing big in R&D, or the Amplify Treatments, Testing and Advancements ETF (GERM) and the newly arrived Amplify Weight Loss Drug & Treatment ETF (THNR) are other examples of ways to think about industry segmentation in a more thematic way.

Granular exposures can deliver the right amount of oomph or diversification both tactical and strategic that you may be looking for.

Take a smart beta “other” approach:

From factors to unique indexes, there are many ways to take an alternate route to broad healthcare. The Invesco S&P 500 Equal Weight Health Care ETF (RSPH) is the easy-button diversifier by simply equal weighting the S&P 500 Healthcare sector. That leads to a smaller-cap tilt and broader overall diversification relative to traditional market-cap portfolios.

Other ideas include the First Trust Health Care AlphaDEX Fund (FXH), which is a quant-driven multi-factor strategy that looks at value and growth metrics for security selection in a tiered equal weight portfolio of healthcare stocks. By comparison, the Invesco Dorsey Wright Healthcare Momentum ETF (PTH) selects and weights stocks based on momentum alone. There are many more.

Take the other “other” route:

Are you looking for something completely different, like income in your healthcare allocation? The Global X Health Care Covered Call & Growth ETF (HYLG) is an ETF looking to deliver that. Want to juice up your ride? Direxion is one of the providers offering juice with ETFs such as Direxion Daily Pharmaceutical & Medical Bull 3X Shares (PILL).

Choose Your Healthcare ETF Adventure

With ETFs, you can choose between various exposure options. Constrast straight-up access to the healthcare sector through classic market-cap weighted portfolios with taking various scenic routes to your intended exposure. There's no single path that's right for everyone, only the path that's right for your own investment goals. A good ETF Screener tool is a great place to start evaluating those choices.

Either way, this is a sector that may be worth a look as you search for value and diversification in a growth-obsessed market.

For more news, information, and analysis, visit VettaFi | ETFTrends.

A message from Advisor Perspectives and VettaFi:more about this and other topics, check out some of our videos.

Read more commentaries by VettaFi