Health Stock Funds: Right Prescription in a Recession?

As the recession unfolds, some drug companies will face weakening sales. But health companies overall are likely to suffer far less damage than businesses in most other sectors.

While health funds offer a sound way to participate in one of the economy's strongest sectors, investors should keep in mind that the portfolio managers follow a variety of different strategies. On the aggressive end of the spectrum is T. Rowe Price Health Sciences (PRHSX Quote), which has returned 3.1% annually during the five years ending in November, outperforming 88% of its peers and beating the S&P 500 by 4.5 percentage points.

Portfolio manager Kris Jenner emphasizes small, growing companies that are developing breakthrough drugs. He has 42% of the portfolio in biotechnology companies. "When a small company develops a new drug, the shares can take off," says Jenner. "But if Pfizer (PFE Quote) develops a new drug that produces $1 billion in sales, that won't have much impact on the stock because the company is already so big."

Jenner says that some of his favorite drug companies should continue reporting growing earnings. A big biotech holding is Gilead Sciences (GILD Quote), which makes drugs used to control HIV. "Patients are not going to cut back on their daily HIV medicines because they understand the risks of the disease," says Jenner.

For a fund that emphasizes blue chips, consider Schwab Health Care (SWHFX Quote), which has returned 5.4% annually for the past five years, outperforming 93% of peers.

The fund employs Schwab's proprietary grading system that rates each stock according to 19 factors. Stocks with growing cash flows and solid balance sheets tend to score highest. "The system steers away from companies that are under stress, and that has helped us avoid trouble lately," says portfolio manager Paul Alan Davis.