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How Health Care ETFs Can Strengthen Your Portfolio

More aggressive investors may be interested in honing in on an industry group like biotech stocks that have been a rocket ship of momentum. The iShares NASDAQ Biotechnology ETF (IBB) has over $5 billion invested in 123 companies focused on developing new innovative pharmaceutical and medical devices. In 2013, this ETF returned a whopping 65.47% gain on the back of stellar performance from some of its largest underlying holdings. Last year wasn't necessarily a fluke either, IBB boasts three-year annualized returns of 34.67% and five-year annualized returns of 26.52%.

Biotechnology stocks are known to be more volatile because of their hit-or-miss business models which often times lead to periods of strong outperformance or underperformance. Often times their stocks are affected by factors such as FDA approval, drug trials, R&D costs, and other unforeseen events. However, they can also lead to big profits when new products are developed and successfully tested.

Another interesting ETF that treads the line between passive and active investing in the health care field is the First Trust Health Care AlphaDEX Fund (FXH). This ETF is a "smart beta" strategy that screens health care stocks for book value, cash flow, and return on assets. It then weights the components according to their scores in these categories. Because the index is rebalanced quarterly, it is being refreshed with companies that have strong fundamental business characteristics.

FXH currently has nearly $2 billion invested in 76 companies. One of the benefits of this strategy is that you get a broader subset of health care stocks that include more small and mid-cap companies as opposed to just large-cap names. The total return of this ETF in 2013 was 47.55% which bested XLV despite having a higher expense ratio of 0.70%.

A quick look at the charts above shows that these ETFs have been aggressively bought on nearly every dip down to their 50-day moving average. In addition, the recent push higher has brought them all the way back in striking distance of new all-time highs. This may not be the optimal point to establish new positions given the lofty heights that they have reached.

I would not be hesitant to add to this sector on a modest pullback that gives you a better opportunity for long-term success. In addition, I recommend that you implement a stop loss or sell discipline to guard against the potential of a protracted decline. Stocks have certainly been more volatility in 2014 than they were last year, but that also means that there may be opportunities to put money to work at more advantageous prices.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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