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Globe Investor Trump, aging population make health-care ETFs compelling

Canadian investors should consider some exposure to the industry for portfolio diversification, experts say.

Graham Hughes/The Canadian Press

U.S. health-care stocks took a beating last year amid worries about drug-price controls but have rallied since Donald Trump was elected president.

While some stocks may no longer be bargains, the sector is still compelling for investors because it can offer steady growth, potential benefits from proposed tax reform and stability during market turbulence, financial experts say.

The rally since November reflects enthusiasm that the industry could gain traction from lighter regulation and lower corporate taxes under a Trump presidency, suggests Christopher Davis (below), director of research at Morningstar Canada.

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Christopher Davis, director of research at Morningstar Canada. The Globe and Mail J.P. MOCZULSKI The Globe and Mail

(J.P. Moczulski/The Globe and Mail)

The market was pretty much expecting Democratic candidate Hillary Clinton to win, and "have a heavier hand when it came to drug regulation," he says. "Even a tweet from her [to tackle 'price gouging'] would send drug stocks reeling."

The political uncertainty hanging over health-care policy has been lifted – at least for now – after Mr. Trump failed recently to repeal and replace the Affordable Care Act. Revoking this law, better known as Obamacare, would have raised the number of uninsured Americans and hurt the individual insurance market.

Despite recent turmoil in the sector, Canadian investors should still consider some exposure to the industry – if they don't have it – for portfolio diversification because health care is a tiny part of the domestic stock market, Mr. Davis says.

The industry tends to be an area of steady growth, and will benefit from an aging population needing medical care, he says. "In China and India, you have an increasing wealthy population and that is always good for health-care spending."

Exchange-traded funds (ETFs) focused on health care allow investors to cast a wider net and avoid the risk of owning a single stock, he says. The industry includes drug makers, hospitals, insurers, medical device makers and biotechnology firms.

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U.S.-listed Vanguard Health Care ETF, which tracks 358 U.S. stocks and charges a 0.10-per-cent fee, is "probably our favourite," Mr. Davis says. Keep in mind that 10 stocks, which include names such as Johnson & Johnson, Pfizer Inc., and Merck & Co. Inc., make up 45 per cent of the portfolio, he notes.

He also likes Canadian-listed BMO Equal Weight U.S. Health Care Hedged to CAD ETF. With 52 stocks having equal weight, there is less concentration in individual names, while its currency is hedged to mitigate any impact, he says. "But it is more expensive with a 0.39-per-cent expense ratio."

National Bank Financial ETF analyst Daniel Straus (below) says that health care is also attractive as a defensive play because its stocks do well in an economic downturn. There is always consumer demand for medical products or services, he says.

National Bank Financial ETF analyst Daniel Straus. The Globe and Mail Kevin Van Paassen The Globe and Mail

(Kevin Van Paassen/The Globe and Mail)

While these stocks have been less volatile than the broader market over most of the past decade, political wrangling over the past year and a half has shaken some of the defensive underpinnings over the shorter term, he acknowledges.

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With baby boomers aging and more efficiencies – and potential higher profits – arising from the adoption of technology, "it is a sector that does make sense as a long-term investment," Mr. Straus says. Many hospitals and health-care providers, for instance, still use paper versus electronic health records, he notes.

Some health-care firms, such as drug giants Eli Lilly and Co. and Bristol-Myers Squibb Co., could also benefit from Mr. Trump's pledge to cut corporate taxes, and provide a tax holiday for U.S. companies with huge cash stockpiles overseas. The president could provide more details on tax reform today. Cash repatriation would mean an inflow of capital that could be reinvested for growth, research and development, or expansion, he says.

As well, the recent passage of the 21st Century Cures Act, which provides for speedier approval for new drugs and devices by the U.S. Food and Drug Administration, could improve profitability at health-care firms, he adds.

Both Vanguard Health Care ETF as well as U.S.-listed Fidelity MSCI Health Care ETF, which tracks 344 U.S. stocks and charges a 0.08-per-cent fee, are cheaper ways to play the sector, he says. Fees matter because they eat away at returns.

For a pure play on drug companies, he likes U.S.-listed SPDR S&P Pharmaceuticals ETF, which charges a 0.35-per-cent fee, and iShares U.S. Pharmaceuticals ETF, with a 0.44-per-cent fee. There is obviously more risk in this bet, but also potentially a higher reward should this sub-sector outperform, he adds.

The health-care sector also holds appeal for income-seeking investors because many of its stocks offer steady and stable dividends, says Todd Rosenbluth, director of ETF and mutual fund research at New York-based CFRA Research.

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Given that CFRA's stock analysts still find large-cap health-care companies to be attractively valued, U.S.-listed Health Care Select Sector SPDR ETF is a good way to get exposure to this part of the sector, Mr. Rosenbluth says. The fund, which has 60 holdings, charges a 0.14-per-cent fee.

Biotechnology firms, which invest millions to develop new health-care products, are likely to show continued growth, he adds. He favours U.S.-listed iShares Nasdaq Biotechnology ETF, which invests in larger-cap biotech firms. The fund tracks 162 stocks, which include names such as Celgene Corp., Gilead Sciences Inc., and Biogen Inc. The fund charges a 0.47-per-cent fee.

Because there could be more volatility in the U.S. market in the near term, Mr. Rosenbluth prefers ETFs holding larger-company names.

"We are eight years into a bull market, and are heading into a time period seasonally when markets start to get choppy," he says, referring to the investment axiom "sell in May, and go away."

"There is also a lot of uncertainty about … whether the Affordable Care Act stays in place, or gets replaced by something else," he says. "The act added people to the health-care system, which drove demand for pharmaceuticals, biotechnology products, medical devices and insurance."

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