A Seasonal Healthcare Portfolio Using VHT
Summary At the request of a reader, I modified my previous biotech portfolio to focus on healthcare. The result of applying the seasonal data of the healthcare industry was a portfolio that outperformed buy-and-hold strategies, both on VHT and SPY. This six-trades-per-year strategy produces improved performance and dividends with decreased risk. (click to enlarge) Another reader request for a modification of the seasonal biotech portfolio : In this case, Lisa wants to build a seasonal portfolio that can effectively invest in the Vanguard Health Care ETF (NYSEARCA: VHT ). I will help her develop such a strategy and back test it against a buy-and-hold strategy, as well as holding the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). Why VHT and not XLV? Though I thought about using the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ) instead of VHT, as it is immensely more popular than VHT as a tool to gain exposure to the health care industry, I decided that Lisa was right in her first choice of VHT. An important reason to use VHT in place of XLV is its dividend. In a seasonality based portfolio, we will be ditching the healthcare ETF at certain times to avoid the opportunity cost associated with the healthcare down season. However, both VHT and XLV pay out dividends. So, another downside arises: missing out on the dividend. VHT is the superior choice here because – as you will later see – we will always be holding VHT at the ex-dividend date, allowing us to gain all the dividends of VHT while not being forced to hold the ETF during underperforming seasons. VHT’s ex-dividend date for its annual dividend (XLV pays quarterly dividends; hence the problem) is usually in December, which is a good time for healthcare stocks. However, this year, the ex-dividend date was in late September. But this does not damage our strategy, as we will also be long on VHT in September. The Seasonality In my original strategy on the seasonal portfolio strategy for the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ), we were long on IBB during November to January, long on utility stocks via the Energy Select Sector SPDR ETF (NYSEARCA: XLE ) from February to May, and stayed out of the market the rest of the year (sell in May), with the exception of holding gold during September, which is when gold tends to outperform. However, simply replacing IBB with VHT in this strategy is arbitrary. Hence, I looked into the seasonality of the health care sector. I found many academic studies on the subject in scholarly journals, most of which concluded the same thing: Health care does best in the fall and winter. A study performed by Equity Clock over the past 20 years produced the following image and the one you saw at the beginning of the article, which both generally sum up what the journals were telling us: stick with health care during fall and winter but drop it afterward. This leaves us with some clear modifications to our previous seasonal portfolio. The act of holding VHT from September to February changes our strategy in the following ways. We no longer need to hold gold, as VHT’s seasonality overlaps with gold. VHT’s seasonality slightly overlaps with XLE, reducing our exposure to XLE by one-third; we will still be in by the ex-dividend date. If we do not add anything to our strategy, we will only be holding two ETFs all year: VHT in the fall and winter; XLE in the spring. So what about the summer? Do we just stay out of the market? Jeroen Blokland, Seeking Alpha contributor, has already answered this question. The solution, according to Blokland, is to hold the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ). This gives us a complete strategy: At February’s close: Sell VHT and Buy XLE A few days before April’s close (check IEF’s ex-dividend date for May): Sell XLE and Buy IEF At August’s close: Sell IEF and Buy VHT The Dividends Ignoring the performance of this strategy and looking at dividends alone, we see we gain exposure to all the dividends we can. A different strategy – for example one in which we buy XLE after March or VHT after September – could result in a drastically lower amount of dividends payouts. It is mere coincidence – and luck – that the strategy that should perform best also gives us full dividend exposure. VHT: Receive one annual dividend payout in September (or possibly December). XLE: Receive one quarterly dividend payout in March. IEF: Receive five monthly dividend payouts (we’ll be on the cusp ends of both May and September’s dividend payouts). And that’s in addition to the performance we can expect from the seasonality of these industries. Let’s now see how this strategy measures up: Results and Conclusion for Investors First, a notation issue: SPY_HOLD: Holding the SPY year-round VHT_HOLD: Holding the VHT year-round SECTOR: The strategy as outlined above The results: As you can see, the SECTOR strategy gives us the best risk vs. reward ratio. The strategy would have allowed us to reduce the downdraw resulting from the 2008 market crash while maintaining a level of growth exceeding both the SPY and the VHT alone. This portfolio has the highest Sharpe ratio – 0.78 – with the lowest max drawdown – -31.37%. In 2014, had you applied the three different portfolios with $100,000, the dividend payouts would have been (without reinvesting dividends): SPY_HOLD: $1832.01 VHT_HOLD: $1130.56 SECTOR: $487.24 (from XLE), $862.12 (from IEF), $1200.71 (from VHT) = $2550.07 Notice that the dividends we receive just from the VHT part of our portfolio exceed that of a VHT buy-and-hold strategy. This is because we are buying VHT with more than $100,000, as XLE and IEF grow our $100,000 into more capital to be used for the VHT purchase. Thus, we come out with more shares of VHT, equaling more dividends, even though we bought VHT later than buy-and-hold investors, whom we can assume bought the stock at a lower price. Overall, this strategy has three main advantages over the buy-and-hold strategies we looked at. First, it has improved cumulative performance. Second, it has the lowest max drawdowns. Third, it has the highest dividend payout. What’s the downside? I can think of two. First is the tax issue, which varies across individuals. If you’re playing this in an IRA, you can come out okay. The second is the increased commissions, as you’ll be making six trades per year, as opposed to one. In the end, you must decide whether the time invested in a seasonal strategy is appropriate for the increased gains and dividends. If you’re interested in seeing some tweaks to this strategy, ask me in the comments section or via mail. I’ll be rolling out my premium Seeking Alpha backtesting newsletter soon, in which I backtest your strategies. For example, if you want to see the above SECTOR strategy tested with different ETFs as the forerunners, just leave your ideas below.