Just as too much medicine can be a bad thing, this year is teaching us that a health care fund that strictly focuses on biotech is a bit too potent for most investors.
As we
noted earlier today, the health care funds that loaded up on the sizzling stocks of these cutting-edge drug companies rose highest last year and are falling furthest this year. Like the growth funds that stuffed themselves with tech stocks in 1999 and early 2000, these funds and their shareholders are finding out what's so often true: One year's magic bullet is often the next year's poison pill. Therefore, even in sector-fund ranks, it usually makes sense to focus those that cast a fairly broad net.
With this in mind, let's shop for health funds that spread their money around the sector, instead of those that focus on a thin slice. This should help you steer clear of niche funds like the no-load
Dresdner RCM Biotechnology fund, which rode biotech to a nearly 82% gain last year and has ridden them down more than 37% so far this young year.
You might be tempted to skip these funds altogether, given their recent performance. After all, all have lost money this year, and they're down more than 24% on average, second-worst only to tech funds. Still, the prospect of oceans of baby boomers spending more on health care and the category's 17.5% average annualized 10-year return may pique your interest.
Relatively Unhealthy
This year's weakness has pushed health care funds' performance below the broader market |
 |
| Source: Morningstar. Returns through March 26. |
Also, when taken in moderation, even with their recent losses, these funds can boost a diversified portfolio without zeroing in on one pocket of the health sector. Most portfolio planners recommend you limit sector-fund investments to 10% or less of your portfolio. If we compare the returns of a portfolio invested in the
Vanguard 500 Index fund, which tracks the
S&P 500, to the same portfolio with a 10% position in the average health care fund, we find the sector fund both raises returns and reduces risk.
The portfolio with the health fund would've beaten the S&P 500-tracking portfolio over the past one-, three-, five- and 10-year periods through the end of February, according to
Morningstar. What you might not expect is that in addition to posting higher returns, the leading portfolio also boasts slimmer losses in its worst three- and 12-month periods.
The Case For Health Funds
A 10% helping of a health care fund provides
an upside boost and some downside protection to
an otherwise S&P 500-weighted portfolio |
 |
| Source: Morningstar. Returns through Feb. 28. |
Beyond guts, buying a health fund today takes some detective work. If you're looking for a broader health fund, you probably know to steer clear of funds with biotechnology in their names, but that still leaves plenty of stealth biotech funds out there. A good rule of thumb right now is to rule out this year's biggest losers -- essentially the ignominious domain of funds focusing heavily on biotechs. This would steer you away from funds such as the broker-sold
Munder Framlington Healthcare, which is neck-and-neck with the
Franklin Biotech Discovery fund with about a 38% loss this year.
In fact, maybe the best way to uncover the category's broader players is to simply look at the health funds that have topped their peers over the past three years because they own enough biotech to keep pace but not so much that their shareholders are looking for their teeth now. If we screen the 43-fund pack for those that beat their peers over the past three years with the same manager at the helm, we come up with three funds.
Here they are, ranked by how well they've held up this year. Let's look them over and then talk about a couple of others you might want to check out.
Hanging In There
These health care funds are having a tough time this year,
but still managing to beat their peers. |
| Health Fund | YTD Return | 1-Year Return | 3-Year Return |
| Vanguard Health Care | -13.5% | 21.8% | 22.3% |
| Merrill Lynch Healthcare | -16.2 | 2.7 | 15.9 |
| Eaton Vance Worldwide | -20.8 | 2.7 | 26.7 |
| Avg. Health Care Fund | -24.2 | -4.5 | 12.1 |
| S&P 500 | -12.5 | -23.7 | 2.9 |
| Source: Morninsgstar. Annualized returns through March 26. |
As you might imagine, funds that maintain solid returns vs. their peers when the chips are down are usually the category's more conservative types. That's the case here, with each fund falling less than its average peer in down months over the past three years.
But don't expect paltry returns. Each of the three funds on our list spread its money around the sector, but each has veteran managers who've beaten their peers and the S&P 500 over the past one-, three-, five- and 10-year periods, according to Morningstar.
The no-load
Vanguard Health Care fund, run by Ed Owens since its 1984 inception, is the perennial star of the category. It's the largest sector fund in the nation with more than $17 billion in its coffers, but Owens still boasts a solid track record. Carrying a portfolio of more than 140 stocks that he only tweaks with infrequent trades, strategically shifting among pharmaceutical stocks, biotechnology, medical services and foreign stocks.
That might sound tame, but he beats at least 85% of his competitors over the past one-, three-, five- and 10-year periods. Yes, he's down 13.5% so far this year, but that beats 95% of the fund's peers, according to Morningstar. Even the fund's expenses are low -- just 0.39%, compared with 1.73% for the average health fund.
Ordinarily, this would be a great choice, but alas, it's beyond most investors' reach. To control inflows, Vanguard has raised the fund's minimum investment to $25,000 on all accounts.
The other two funds on our list,
Merrill Lynch Healthcare and the
Eaton Vance Worldwide Health Sciences fund, carry loads or sales charges. But after we look at these, we'll check out one or two no-load options.
Jordan Schreiber, who stopped by for a
10 Questions interview last year, has run the Merrill Lynch Healthcare fund since 1983. The core of his fund is invested in big-cap pharmaceutical stocks, but like Vanguard's Owens, he opportunistically shops around the sector to fill out his portfolio.
Like Owens, he beat his average peer and the S&P 500 over the past 10 years, but his measured style is also keeping the fund afloat in this year's tempest. The fund's 16.2% loss so far this year beats more than 85% of its peers, according to Morningstar.
Sam Isaly's Eaton Vance Worldwide Health Sciences fund is down more than 20%, but that still beats the vast majority of his competitors. Isaly, who has run the fund since 1989, lives up to his fund's name by investing nearly 30% of the fund's money in foreign stocks. At home, he invests in both big- and small-cap companies, and like Owens, he doesn't trade much compared with higher-octane peers.
The fund's 22.7% 10-year annualized gain beats 90% of health funds and tops the S&P 500 by more than 7 percentage points.
Two no-load funds that do-it-yourselfers might check out: If you're aggressive and a biotech fan, look at the
Dresdner RCM Global Health Care fund. Otherwise, check out the
Icon Healthcare fund.
The Dresdner fund is co-managed by Drs. Michael Dauchot and Faraz Naqvi. The pair took the reins in 1999. They're riskier than most, paying decent attention to biotech stocks, which makes sense, as Naqvi co-manages Dresdner's biotech fund. But if you're an aggressive investor looking for a fund that fishes in the biotech pool -- without jumping in it -- this might be worth a look.
The fund's 22.4% three-year annualized gain beats 88% of its peers, and its 5.2% loss over the past year only narrowly trails the category average. That said, the fund's biotech appetite is at least somewhat responsible for its more than 27% loss so far this year. If you can handle that kind of volatility, you might look at this fund.
If you can't stomach the prospect of that volatility, you might check out the Icon fund, where lead manager Craig Callahan and his colleagues use a series of quantitative screens to rotate around the sector in search of strong earnings growth and modest valuations. That price-conscious approach has led the firm to post solid returns with less risk in other sectors, and it's doing so here.
The fund's 11.4% average annual gain over the past three years is right around the category average; the 20.5% return over the past 12 months beats 93% of its peers. And its 7.9% loss so far this year is the lowest in the category.
There you have it: a handy field guide for those brave souls traveling into the troubled health care sector.
