XLV: Offering Investors An Interesting Blend Of Defensiveness, Price Appreciation And Income Growth
Recent weakness in the Healthcare sector led me to look at XLV as a means to increase my exposure to a space in the market that I’m attracted to. XLV offers me yield, income growth, and exposure to the entire healthcare sector, including many growth-oriented companies that I likely otherwise wouldn’t have exposure to. I’m typically not a fan of ETFs or other funds due to expense ratios; however, XLV’s is a very low 0.15%. On Monday, in the midst of the market wide sell-off, the destruction in the healthcare sector, specifically, caught my eye. I’ve been overweight in healthcare for awhile now, feeling strongly that as science and technology improves, modern medicine will so too. When looking for reliable growth in the markets, healthcare seems like the safest best. What’s more, many of the more established companies in the sector have been generous in the past with their shareholder returns and offer investors strong dividend growth histories. Recently, there has been drama in the space with regard to the pricing of drugs in the market place. This issue has made it into a political theater, and now, the sector as a whole is trading in response to announcements, and even tweets, made by politicians. Personally, I like my stocks to trade on earnings releases based on fundamental ratios; however, I understand there there is regulatory worry in the space, especially when presidential candidates are coming out strongly against what’s being referred to as “price gouging” in the media. I get it, the recent events centered around Turing Pharmaceuticals and its purchase of and ensuing price hike of the drug Daraprim has caused quite a stir. Honestly, I’m somewhat impressed by the notoriety that this has gotten on Capitol Hill – it seems as though this issue, more so than any other in recent memory, has drawn bilateral support from both Democrats and Republicans. And now, this sense of ire is being directed at the industry as a whole. However, I think it’s important for investors and politicians alike to understand that the Turing situation, compared to something that many view as being rather similar – we’ll use Gilead’s (NASDAQ: GILD ) pricing of Solvaldi, which made big news with regard to potential congressional oversight last year, as an example – is a very different situation. There are many more potential companies and/or drugs that I could use here, but regardless, most of these situations are like comparing apples to oranges. While Gilead spent the time, energy, and financial resources to develop Solvaldi and its other hep C treatments (treatments that don’t merely treat, but cure a potentially deadly disease that causes pain and suffering worldwide), all Turing did was buy the rights to an existing drug and hike the prices. Some might see both situations and think to themselves, “Either way, the treatments are overpriced and this is immoral.” I, however, see them as quite different beasts, with one being quite a bit more justified than the other. Biotech companies put a lot of resources towards their pipelines, and when they’re successful in developing treatments, they ought to be rewarded. As terrible as it might sound, when financial incentive to create such treatments disappear, I imagine that the treatments will as well. Governments worldwide have enough of a hard time funding themselves as it is… I don’t see them doing nearly as good of a job with biotech R&D as the private sector has. Everything comes with a cost in life, and the way I see it, good health is something that is actually worth paying for (and investing behind). But all personal opinions aside, the biotech space is no stranger to dramatic attention by the news media. For years, it seems, the healthcare sector, namely the more volatile biotech names within who are responsible for developing breakthrough drugs and treatments, have been either darlings or devils in the market’s eyes. This attention has allowed for bubbles to form, and pop, and form again. This volatility leads to more attention, and it seems as though the cycle is never ending. In recent years, when these bubbles have burst, the ensuing weakness turned out to be a great buying opportunity for those with the stomach to brave the bloodshed. Now, looking at present weakness, I have to decide if this will be the case again, or if the tides really changing due to a potential political overhaul of the system as a whole. And if I decide that this dip is just that, a dip, I need to figure out when and how should I add to my exposure in the space. Before I go on any further, I will note that I am not a doctor of any sort. I try my best to stay up-to-date on the pipelines of the companies that I own in the space, understanding what each company is setting out to do and whether or not it seems to be achieving its goals from both a scientific and financial standpoint. Due to my limited understanding of the science involved in the inner workings of biotech companies, this can be very difficult for me, and I admit that I rely on third-party sources a lot of the time for my information. I’ve found sources that I trust, and my system has worked out thus far; however, I think it’s worth mentioning that this strategy adds another element of speculation into the overall equation, because my due diligence is sometimes influenced by outside resources. And it’s this point – the fact that I think that many, if not most, self-directed investors don’t have a very good understanding of the healthcare sector as a whole (especially the biotech space, which drives a lot of growth) – that led me to write this article. Although I don’t currently own any ETFs in my personal portfolio, I’m tempted to buy shares of the Health Care Select Sector SPDR ETF (NYSEARCA: XLV ) on recent weakness. The overarching, diversified nature of this ETF would help to cover my tracks a bit as I wander through the sector, somewhat uninformed, while still allowing me to reap the rewards that the space has traditionally had to offer. There are several reasons why I’m attracted to the idea of buying XLV. Namely, right now I’m seeing a lot of deals in the space, and I don’t have enough money to enter into positions with all of them. And what’s more, even if I did have enough money to buy shares in all of them, it’s likely that the commissions I paid to half or even full positions for my portfolio, would equal out to be greater than the 0.15 total expense ratio that one pays when owning shares of this sector SPDR ETF. XLV’s holdings are comprised of many companies that I respect. Sure, there are some that I wouldn’t purchase outright in the market. This is typically the reason that I don’t own ETFs – I’d rather approve of all of the companies that I have exposure to, than simply buying buckets of stocks that contain shares of mismanaged or stingy companies; however, in this case, there are many more positives than there are negatives, and the overall sum of the parts with regard to XLV has received a passing grade. Another reason is this: Because of the diversified nature of the XLV portfolio, I’m given exposure to many more growth-oriented companies than I would be when stock picking, while still receiving a decent yield with above-average growth. I say above average because looking back at annual dividend payments investors received from holding the S&P 500 tracking index (NYSEARCA: SPY ) and XLV, during the last 11 years – from 2005 to 2015 – the income stream of those investors holding XLV had an 8.84% CAGR, while the income stream of those holding SPY had a 6.62% CAGR. The way I look at this, buying XLV allows me to have exposure to growth companies like Regeneron (NASDAQ: REGN ) or Celgene (NASDAQ: CELG ) – two companies with exciting pipelines, but no dividends – while still generating portfolio income. Here is a list of the fund’s top 10 holdings: (click to enlarge) (Source: XLV website ) Now, the downside to this higher growth potential, from both a stock price and dividend payment standpoint, is that my starting yield is lower when buying XLV than it would be if I were to narrow down my selection and purchase shares of healthcare dividend stalwarts like Johnson & Johnson (NYSE: JNJ ), Merck (NYSE: MRK ), Bristol-Myers (NYSE: BMY ), or even the aforementioned GILD, which isn’t exactly a “dividend stalwart”, though it is a company that I’m very long on, and one that I believe will pay a large part in my personal portfolio’s income stream moving forward. Right now, XLV is offering investors a 1.50% index yield, which is much lower than the 2%, 3% or even 4% yields that can be found from rather reliable companies in this space. Anyone investing in this index has to weigh these two options: single stock ownership with a potentially higher yield, or a more diversified, industry-wide exposure with less initial yield, but relatively similar dividend growth potential and greater price appreciation potential. Medical degree or not, it doesn’t take a genius to see that the healthcare sector has drastically outperformed the S&P 500 in recent years. Looking back even 20 years, we see that this sector of the market has been a top performer. This is clearly shown in this graph, which is a year or so outdated; however, I think it still has a point to prove, and I couldn’t find another with more recent data that painted such a clear, broad picture of the markets. (click to enlarge) (Source: Bernstein ) Looking at a similar data set through a more narrow lens, we see that over the last 10 years, XLV has outperformed not only the S&P 500, but also some of its major components that I choose because of my own interest in them (and the fact that I assumed other dividend income investors might be interested in them as well) – Johnson & Johnson and Pfizer (NYSE: PFE ) – by a long shot. (click to enlarge) Here is another image that I came across when looking at long-term asset class return results; I find it interesting that in this graph, not only has healthcare found itself among the very top performers since 2011, but in 2008, when the bottom fell out of the market, the healthcare sector was defensive in nature as well, with the second best overall sector-wide performance, behind only consumer staples. It’s not often that one is able to find defensiveness, growth potential, and income/income growth all in the same spot; however, it seems that with healthcare, investors get the complete trifecta. (click to enlarge) (Source: Sector SPDR Website ) And speaking of income, I went ahead and put these graphs together to show interested investors that not only do they get strong stock price appreciation potential with XLV, but also strong income growth. I know I mentioned the CAGR before, but this gives a more complete version of the picture. Here is a chart showing XLV’s quarterly dividends since 2005 (the fund’s inception date is 1998, but I thought a 10-year data set would suffice). (click to enlarge) Although the payments are a bit sporadic and not exactly predictable on a quarter by quarter basis, the overall trend is clearly to the upside. Here is another image I put together, comparing XLV’s dividend growth to that of SPY. As you can see, growth for XLV has been more reliable, especially in tough times. (click to enlarge) So, in conclusion, after looking over XLV as a potential holding, I came away impressed. Obviously, everyone’s portfolio management strategy is different, though I’m starting to realize that having exposure to these low-expense sector ETFs could be beneficial for me, especially from a diversification standpoint, and I will likely begin including them into my holdings. I am not currently long XLV, though it is a stock that is sitting near the top of my current buy list once the market calms down a bit and I get more clarity of certain global and Fed-related issues that I’d like to see play out before putting cash that I’ve recently raised back into the markets. I invite any and all readers to perform their own due diligence on XLV, because I think that right now, with it trading down 8% on the month, interested investors might find an attractive entry point into the space. I should also mention that I chose to focus on XLV rather than the often-talked-about iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) because of the lack of yield associated with the latter. I like the growth potential of sector, and especially the biotech space within; however, I’d like to get some yield from my money invested, so XLV seemed like the perfect compromise. Those looking for more of a growth pure play may want to take a closer look at IBB while you’re at your XLV due diligence as well.
