Investing in the Healthcare Sector through Mutual funds and Exchange Traded Funds

At In Sickness and Wealth, we believe that investors of all levels will benefit from what we have to offer. Whether you are new to the investment process or have some experience investing, we hope to educate you on how to allocate to the healthcare sector efficiently and at the lowest cost possible. With dozens of products available, Mutual funds and Exchange Traded funds (ETFs) that focus on the healthcare industry are a great place to start. In this article, we will cover only mutual funds and leave ETFs for a future article.

Healthcare sector mutual funds have several benefits:

  1. Mutual funds allow an investor to test the waters with smaller sums of money. While most mutual funds require $1,000 to $3,000 as a minimum initial investment (lower for IRA accounts in some cases), several healthcare sector mutual funds are available with minimum initial investments of as little $100 -$500!
  2. Mutual funds allow less experienced investors access to a diversified investment portfolio of dozens of stocks. Assembly of a comparable portfolio on your own would require significantly greater expertise and capital.
  3. Mutual fund investors enjoy professional management, hence, those lacking the time or the inclination to manage their own money, can turn to a professional money manager. There are dozens of healthcare sector mutual funds available; some possessing excellent long term track records. We will discuss some of the basics here, and in future issues cover these important instruments in greater detail.

Figure 1 lists many of the healthcare sector mutual funds available today. The list has basic information such as the fund name, the ticker symbol, the minimum initial investment to open an account, net asset value, and the expense ratio (a very important number that can have great impact on your results). It also has 5-yr and 10-yr annualized returns. The last two columns—standard deviation and Sharpe ratio—are two primary gauges of risk. In Sickness and Wealth will always be equally concerned about risk as with reward, and we’ll go to great lengths to ensure readers have some understanding of risk.

Figure 1: Healthcare Sector Mutual Funds

Figure 1: Healthcare Sector Mutual Funds

So how does one sift through all this data and choose a fund for consideration? For instructional purposes, we will highlight three funds from Figure 1 (they are highlighted in red). The Vanguard Healthcare fund, the Hartford Healthcare fund and the Proshares Biotech Ultra Sector fund. We will focus on four columns in particular: The expense ratio, the 10-year annualized return, the 3-yr standard deviation and the Sharpe ratio.

Vanguard Hartford Proshares Biotech
Expense ratio .34 1.27 1.56
10 yr. ann. Return 11.82 11.06 17.31
Standard deviation 11.07 13.45 29.56
Sharpe ratio 2.23 1.83 1.57

The annual expense ratio is simply the operating costs of the fund that are passed on to the investor. These costs can vary widely. In this case, the Vanguard fund is substantially cheaper than the other two choices. This is significant as John Bogle, the founder of Vanguard constantly says, “costs matter.” Heavier fees weigh on returns especially when you consider the long run.

For the next comparison look at the 10-year annualized returns. Vanguard has a slight edge by .76% over the Hartford fund. However, the clear winner is the Proshares Biotech fund by a wide margin. Be careful now. Many investors, especially newcomers, focus too much on returns and not on risk. The next statistic is standard deviation. It’s a commonly used measure of price movement or risk. In general, the higher the standard deviation, the greater the price fluctuations or risk. Stay with me here. In general, in the investment world, the greater the risk you take, the higher your returns should be. But not always! In this case, the Hartford fund had 20% greater risk as measured by standard deviation but underperformed the Vanguard fund. So in this case you were not rewarded for extra risk. The Hartford fund had lower returns over the past decade, despite the greater risks taken. Ideally, you want to get the best return possible consistent with the lowest risk. The Sharpe ratio is a portfolio statistic that measures this and the Vanguard fund has the larger Sharpe ratio. Sharpe ratio tries to measure returns with respect to risk.

At the top of the performance chart is the Proshares biotech fund with a 17.31% annualized return over 10 years. While this is a great return, examine the risks taken to achieve those returns. Its standard deviation is 29.56—substantially higher than most of the other funds. That kind of risk is wonderful if biotech stocks are marching higher as they did in the years 2013-2015. But if they should ever reverse course—as they did in August of 2015, the declines will be painful. Remember, risk is a two-sided coin—it’s your friend in a bull market and your enemy in a bear market.

Looking at other potential fund candidates, notice the T. Rowe Price Health Sciences fund. It’s near the top of the chart with a 10-yr annualized return of 16.43% – only slightly less than the Proshares return. Its risk, or standard deviation however, is much lower than many of the top ten healthcare mutual funds and about half of the Proshares fund risk. This is what portfolio management is all about. The manager of this fund took less risk than many competitor funds, but still managed excellent returns. All the major rating services such as Morningstar rank this fund pretty high—and it should be no surprise given its risk/reward characteristics of the fund.

In future articles/blogs/issues, we will go cover additional topics of risk/return and portfolio construction as well as provide coverage of healthcare sector ETFs.

Disclaimer: While these statistics are real, and these funds are available for investment, writing this article is for educational purposes only and does not constitute investment advice regarding the Vanguard Healthcare fund and the Hartford Healthcare fund.

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