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5 Health Care Funds for a Healthy Portfolio

By William Ehart of InvestorPlace

The notion that health care stocks and mutual funds are recession resistant or defensive in nature has been lost in a thicket of worry about stocks in general as well as sector-specific fears about health care reform and patent expirations. Major pharmaceutical stocks with rock-solid financials are lagging on growth and regulatory concerns; biotechs offer growth and innovation but can't get a break as investors flee risk.

In today's market, investors would rather collect 2.95% on Johnson & Johnson (JNJ) 10-year bonds than 3.70% on its common shares.

But we don't need to look far afield for evidence health care stocks can offer shelter from the storm. The sector held up much better than the Standard & Poor's 500 Stock Index during the 2008 bear market, although it lagged in last year's rebound. The Biotech HOLDRS (BBH) actually gained 10% in 2008 versus the 37% decline of the S&P 500. But the shares rose just 11% last year compared with the nearly 27% gain of the market.

When all is said and done, the Biotech HOLDRS, the iShares Health Care Select Sector SPDR (XLV) and all the funds listed below have outperformed the S&P 500's 9% loss over the three years ended Thursday.

Meanwhile, valuations in the sector are at historical lows. According to data cited in the latest quarterly T. Rowe Price Report newsletter, health care valuations haven't been this low since a Clinton-era attempt at health care reform put fear into the markets in the early 1990s.

The data, compiled by Ned Davis Research using earnings estimates from Zacks Investment Research, show the price/earnings ratio of the S&P Health Care Sector is just 85% of that of the S&P 500 as a whole. Historically, the sector has traded at a premium to the index, and often a substantial one.

Concerns about the impact of President Barack Obama's health care reform, slower drug approvals, patent expirations and a lack of blockbuster new products from big pharmaceutical companies are very real. But the savvy portfolio managers behind some of the nation's best health care funds say the sector is due for a rebound given low valuations and even lower expectations. The likelihood health care reform will prove less onerous than expected also is real.

All of the following funds are rated four or five stars (out of five) by independent mutual fund rating firm Morningstar. All are no load, have expense ratios below 1.5% and have had the same portfolio managers for at least three years. Each is significantly less volatile than the overall market and held up substantially better than the S&P 500 during the bear market.

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