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Health Care Fund Loses 'Defensive' Quality

Billy Fisher

It has been anything but a year of wellness for health care providers.

The iShares Dow Jones U.S. Healthcare Provider Fund (IHF Quote) has fallen 47% so far this year, more than the S&P 500's 32% decline.

The ETF returned 18.3% in 2007 vs. 5.5% for the S&P 500. The underperformance was unexpected in 2008, in light of the fact that many investors sought out less-risky asset classes as the year unfolded. Historically, an investment in health care would have sounded like a good place to be, given its defensive nature. This notion has proven to be anything but the case.

IHF, whose top holdings include UnitedHealth Group(UNH Quote), WellPoint(WLP Quote), Medco Health Solutions(MHS Quote), Aetna(AET Quote) and Humana(HUM Quote), ran into trouble early on in 2008.

In March, WellPoint slashed its full-year forecast due to higher-than-expected medical costs. Humana followed the lead two days later while blaming revised projections on the performance of its Medicare Part D plan. In April, UnitedHealth continued the trend when it reported its first-quarter results. Unusually high influenza costs and a decline in membership for its risk-based commercial markets products were cited as contributing factors to a downward revision in its full-year outlook.

IHF's slide raises the issue as to whether the ETF is a bargain or value trap. It's now trading at $39, down from its 2008 high of $64.

"We put a 'sell' rating on it when it broke below $59 in January," said Philip Yockey, president and chief investment officer of Tactical Analytics, an independent private research company. "Right now you are at a price that you only see 5% of the time. Either it's cheap or something has fundamentally changed."

Eric Aanes, president of Titus Wealth Management, concurs with Yockey that valuations in the sector have improved. "Health care is a good defensive play," he said. "It has been long overdue and valuations are attractive in the sector."

Aanes prefers some of the large-cap pharmaceutical companies over health care providers, including Pfizer(PFE Quote). "The stock has a good dividend yield that is now in excess of 7% and the company has a strong balance sheet," he said.

Aanes also likes drug manufacturer Teva Pharmaceutical Industries(TEVA Quote). In late July, Teva reported second-quarter results that included a 3% increase in EPS on an 18% spike in net sales vs. a year earlier. The company benefited from new product launches in the U.S. and strong international sales growth.

Paul Alan Davis, a manager of the Schwab Health Care Fund(SWHFX Quote), says that relative to other sectors, health care should be a safer area of the market at least until mid-2009. The manager, whose fund has fallen 30% this year, is underweight in managed-care companies. SWHFX has outperformed 92% of its peers over the past five years.

Two positions in the space that Davis has held on to are Aetna and Cigna(CI Quote). "Their fundamentals are showing the ability to generate strong cash flows," he said. "Both companies are repurchasing shares and have done a good job with the timing of their repurchases."

The focus on fighting rising medical costs is a trend that has led to opportunities for Davis. Two of his top 25 holdings that also play a prominent role in IHF include Medco Health Solutions and Express Scripts(ESRX Quote). "We are continuing to hold pharmacy benefit managers," he said. "Being involved in medical-cost containment, they are positioned for increased positive attention."