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The health-care sector’s recent strength is attributed to a mix of factors including a lack of options for investors, advances in biotechnology, strong revenue growth for the big pharmaceutical companies and growing demand from aging baby boomers.Artem Samokhvalov/Getty Images/iStockphoto

In the first three months of the year the S&P 500 Health Care Index, a basket of the biggest health-care stocks, grew 21 per cent – accelerating a one-year return of 30 per cent.

Over the same quarter, health-care equity funds dominated other asset classes with an average three-month return of 11 per cent, capping off a one-year return of 21 per cent.

The CI Global Health Sciences fund led the way with a first-quarter return of 20 per cent and an annual return of 44 per cent. Fund manager Andrew Waight attributes the sector's strength to a mix of factors including a lack of options for investors, advances in biotechnology, strong revenue growth for the big pharmaceutical companies and growing demand from aging baby boomers.

"Health care is driven by demographics as populations in developed markets age. It's also driven by geographic expansion through the rise of the middle class in regions like Turkey, Eastern Europe, Brazil and China," he says.

Mr. Waight, who holds degrees in genetics and biochemistry and has managed the fund since 1999, also attributes the market popularity of health care to a better understanding of recent scientific advances. "What I think the market missed most is the fundamental understanding of biology and how that has improved over a number of years."

He says advances have been accelerated by the partnering of big pharmaceuticals and biotechnology companies to work through costly patent issues and create better product pipelines.

He uses three of his top holdings to make his point. As a big pharmaceutical company, revenue growth for Merck & Co. Inc. has traditionally been bogged down by chemical drug development. "Their background is coming up with little white pills to help solve disease problems or relieve symptoms," he says. "With those small white pills you file a patent for 20 years and in the end generics come in and knock off your small white pill because all the patent information they need is out there."

He says Merck's transition from chemical to biotechnology has helped to boost annual top line growth in the 6-per-cent range and helped propel its stock price by 14 per cent so far this year.

On the biotech side he says companies such as Biomarin Pharmaceutical Inc. and Roche Holdings A.G. are less regulated and have better pricing power through longer patent lives, which raise the barriers for generics to compete. "Biotechnology companies are smaller, more entrepreneurial, perhaps riskier and more flexible in the decisions they make. They often go after drugs that are injectable and made in cells rather than by chemical synthesis," he says.

He says a big appeal for Roche is its involvement in the burgeoning field of oncology, the study and treatment of cancerous tumours. "We've known all the pathways that drive a cell, that turn it to a cancerous cell and drive tumour growth. We now know all the spots in those pathways where we can aim drugs, and Roche is a leader in that regard."

Shares in Roche have advanced by 19 per cent so far this year and Biomarin has returned 30 per cent over the same period.

By Oct. 1, big changes are expected to come to the health-care sector with the expansion of federally funded medical insurance in the United States, which has been derisively dubbed Obamacare by his opponents. One of the biggest pieces of U.S. social legislation since the 1960s, the Patient Protection and Affordable Care Act will allow consumers to buy private health insurance at subsidized rates intended to make the coverage affordable for those with family incomes of up to $90,000 a year.

By next year, 32 million previously uninsured Americans are expected to have some form of medical coverage. "In 2014 the main tenets of Obamacare kick in and that will have consequences for a number of subsectors in health care. There will be winners and losers," Mr. Waight says.

He believes his portfolio is well positioned for Obamacare. One stock he feels has the most to gain is the fund's largest holding. HealthSouth Corp. is the biggest health-care rehabilitation service provider in the United States and is expected to benefit from the fixed payment and national reimbursement system proposed under Obamacare. Shares in HealthSouth have risen 22 per cent so far this year.

Not everyone is convinced of the long-term vitality of the health-care sector. New York-based research firm WBB Securities president Steve Brozak says the sector's only appeal is its ability to generate short-term cash.

"They're cash generators," he says, pointing out stocks such as Roche and Merck that pay dividend yields above 3 per cent. He attributes the popularity of the health-care sector not to its innovation, but to its ability to pay the highest yields – yields that cannot be sustained. "I don't see how it's possible without any tectonic shifts in products."

Mr. Brozak advises clients to avoid the sector because most of its positive attributes such as high dividends, shifting demographics and new scientific advances have already been priced into the stocks. "It would be presumptuous for investors to go out there and say that they were going to invest based on any government regulation or demographic shift which has been going on for the past 20 years," he says.

His caution goes even further, comparing the run-up in health-care stocks to the 2007 housing bubble in the United States. "People say how can you lose money in health care? The reality is they can lose it very easily," Mr. Brozak says.