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Summary Supplementing your core ETF portfolio with smart sector bets can lead to healthy returns. Powerful demographic and related trends make health care one such sector, and now may be a good time to get in. However, there are risks. A quality ETF can help to mitigate these. I share my suggestion as to the one you should choose. When building your ETF portfolio, it is good to start with the basics. In my previous work on Seeking Alpha, I have suggested a simple, yet powerful and globally-diversified portfolio based on just 3 ETFs . However, you may wish to enhance such a basic approach by supplementing it with ETFs targeted at certain sectors of the marketplace. REITs are one such possibility. In a follow-up article , I built a four-ETF variant of the base portfolio that includes REITS. For this article, however, let’s take a look at another sector in which you may want to make a targeted investment. I will also suggest that you use a specific ETF to do so. Why Health Care? Why Use an ETF? In my personal portfolio, I have chosen to add a targeted investment in the health care sector. Why? Please allow me to share just a couple of quick items I found when researching this topic. We have an aging population. Consider the following, from the Administration on Aging , part of the U.S. Department of Health and Human Services: The older population-persons 65 years or older-numbered 44.7 million in 2013 (the latest year for which data is available). They represented 14.1% of the U.S. population, about one in every seven Americans. By 2060, there will be about 98 million older persons, more than twice their number in 2013. People 65+ represented 14.1% of the population in the year 2013 but are expected to grow to be 21.7% of the population by 2040. Not surprisingly, with an aging population comes increased costs for health care. Consider two excerpts from a report on aging from the Centers For Disease Control : The increased number of persons aged > 65 years will potentially lead to increased health-care costs. The health-care cost per capita for persons aged > 65 years in the United States and other developed countries is three to five times greater than the cost for persons aged 65 years ($12,100), but other developed countries also spent substantial amounts per person aged > 65 years, ranging from approximately $3,600 in the United Kingdom to approximately $6,800 in Canada ( 13 ). However, the extent of spending increases will depend on other factors in addition to aging ( 12 ). The median age of the world’s population is increasing because of a decline in fertility and a 20-year increase in the average life span during the second half of the 20th century ( 1 ). These factors, combined with elevated fertility in many countries during the 2 decades after World War II (i.e., the “Baby Boom”), will result in increased numbers of persons aged > 65 years during 2010–2030 ( 2 ). Worldwide, the average life span is expected to extend another 10 years by 2050 ( 1 ). The growing number of older adults increases demands on the public health system and on medical and social services. Chronic diseases, which affect older adults disproportionately, contribute to disability, diminish quality of life, and increased health- and long-term-care costs. In summary, the reports reveal that, due to longer life spans, people often live longer with chronic disease. Sadly, factors such as obesity and diabetes, more and more common in our culture, also lead to greater need for medications and other health care support. Finally, technological advances are making possible the treatment of certain conditions that simply could not have been treated in the past Certainly, factors such as these bode well for the long-term outlook for health-care related products and services. At the same time, investment in the health care sector is not without its risks. For example, pharmaceutical companies must spend vast amounts on R&D to develop and bring new drugs to market. But getting a drug to market is no small task. To begin with, it is a real challenge to identify and develop new chemical compounds for such drugs. And even once a potential drug is developed, it must go through rigorous clinical trials before it is approved for sale to the public. Needless to say, not all drugs make it through this process. This is where the ability to use an ETF to invest in health care can be, well, good for your investment health. I will get into the specifics of our focus ETF as it relates to this matter in just a little bit. Why Now? I have been hoping to write an article on this topic for some time. Why did I choose to do so now? The impetus actually came from this news item right here on Seeking Alpha. I won’t bother recapping it; it is short and you can read it for yourself. But here is a picture that will make very evident what the quoted analyst was getting at. VHT data by YCharts The blue line represents the Vanguard Health Care ETF (NYSEARCA: VHT ), the focus of our article. The yellow line represents the broader S&P 500 index. As can be seen, there was a roughly 12% gap between the performance of this index and the S&P 500 just a little earlier this year. Due in large part to recent concerns having to do with the biotech sector, that YTD gap has narrowed to a mere 1.2%. As the quoted analyst suggests, this may offer a good opportunity to either enter, or add to your position in, this sector. The Power of VHT Earlier, I briefly touched on some of the risks involved in investing in the health care sector and suggested using an ETF to mitigate such risk. Simply put, this is because a well-chosen ETF will allow you to remain well diversified, thus lessening single-company risk. As alluded to earlier, in this article I chose to focus on the Vanguard Health Care ETF. This ETF is based on the MCSI US Investable Market Health Care 25/50 Index . Let’s start with a closer look at that index, in the below picture taken from the factsheet for the index. (click to enlarge) Here are a few things worthy of note: There are 349 constituents, or companies, in the index. The Top-10 holdings comprise some 44.96% of the overall index, and are mostly large-cap pharmaceutical companies. This is also reflected in the overall 36.58% weighting of pharmaceuticals in the index (see pie chart). However, this risk is somewhat balanced by the inclusion of McKesson Corp. (NYSE: MCK ) and similar companies involved in the distribution of health care products, and UnitedHealth Group (NYSE: UNH ) and similar companies involved in healthcare services. This diversifies your risk, as the pie chart shows, across various sub-industries within the overall health sector. If you look at the Portfolio and Management tab of the factsheet for VHT, you will notice that this ETF is extremely faithful in tracking this index. Vanguard supplements this with a rock-bottom expense ratio of .12%. The fund’s total net assets of $6.1 billion and average daily trading volume of $58.37 million mean that the fund is extremely liquid, leading to a low .07% trading spread (the average difference between “buy” and “sell” transactions). I would hope you hold this ETF for the long term, but the above figures will hold you in good stead should you need to trade. Finally, VHT carries a 1.45% distribution yield, which Vanguard recently shifted from being an annual distribution to a quarterly distribution, which I really love. Summary and Conclusion I believe health care is a great sector in which to make a targeted investment. In this article, I have recommended using an ETF to do so, and featured the Vanguard Health Care ETF as what I believe to be your best tool to do so. This excellent choice gives you tremendous diversity across the sector, coupled with a low expense ratio and great liquidity. Happy investing! Scalper1 News
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