The Big Screen: Health-Sector Funds That Provide Long-Term Vigor

Health care funds are hot this year. But picking the right one for the long haul requires looking at the group under a microscope.

Thanks to a hot streak for biotech stocks and a recovery for big-cap pharmaceutical stocks, health care funds have throttled every other sector-fund category this year. Since Jan. 1, the average health care fund is up 42.7%, more than doubling runner-up real estate funds' 16.6% gain, according to Morningstar.

And investors have noticed, stuffing $7.5 billion in fresh cash into health care funds through May 31, $2.5 billion more than they've sunk into S&P 500 Index funds, according to Boston fund consultant Financial Research.

But health care funds are a varied bunch. Simply picking this year's top performers could leave you with a biotech-heavy fund and a heaping helping of risk in your portfolio. So, this week the Big Screen turns to the health care pack.

No single screen whittles the group to one menu of good ideas, so we'll list funds that have beaten their average peers over the past three years and have had the same manager during that period. We'll sort them into diversified health care funds for more moderate investors and biotech funds for the aggressive crowd. As usual, we'll cover some solid choices that made our list and some that missed the cut. Here's our list, ranked by year-to-date return.

Long-Term Health These health care mutual funds have been stellar performers for the past three years.
Healthcare Fund	YTD Return	3-Yr. Annualized Return
(MFHYX)Munder Framlington Healthcare	81.5%	39.7%
(ETHSX)Eaton Vance Worldwide Health Sciences	69.3	35.6
(VGHCX)Vanguard Health Care	37.7	28.4
(MAHCX)Merrill Lynch Healthcare	34.7	27.7
Avg. Healthcare Fund	42.7	23.9
S&P 500	-1	18
Source: Morningstar. Performance figures through July 6.

The key in looking for a health care fund is to first decide whether you're after a biotech fund or a diversified health care fund. Biotech companies are essentially cutting-edge labs that develop new drugs and other remedies. When sector-related breakthroughs such as the mapping of the human genome makes news, their stocks can run up in a hurry, but they're often feast-or-famine performers.

This year, the Nasdaq Biotech Index is up 48.1%, following up on last year's 102% gain. But in 1996 and 1997, the Index turned in a combined 7.8% loss.

"I would say a biotech fund is probably not for most investors. A more general health care fund is much more suitable," says Valerie Putchaven, a Morningstar analyst who covers health care funds.

The idea, of course, is that a health care fund that spreads its assets more broadly across the sector still will give you access to the mercurial biotech sector, with the leeway to de-emphasize biotechs when volatility rears its ugly head.

"I have high esteem for biotech and genomics [companies], but valuations are high and trees don't grow to the clouds. That's why we're diversified," says Jordan Schreiber, who's managed broker-sold (MAHCX)Merrill Lynch Healthcare since 1983. He typically blends biotech holdings with less-volatile pharmaceutical, hospital, and medical-device stocks.

Though he shies away from drastic sector bets, his diversified health care fund sports a 29.2% annualized return over the past five years, which beats 85% of his peers and leads the S&P 500 by more than 5 percentage points.

The best example of a diversified health care fund, however, might be the third fund on our list: no-load (VGHCX)Vanguard Healthcare, run by Ed Owens, a man many consider to be the category's guru. "Vanguard Healthcare is the top choice. You're getting an experienced manager known for being in the right place before others," Putchaven says.

Owens, who's run the fund since 1984, employs a low-turnover style that's led to a 23.7% annualized return over the past 10 years. That beats 80% of its peers and leads the S&P 500 by nearly 6 percentage points. That's particularly impressive when you consider that Owens' $12.7 billion fund is far and away the category's biggest, with about one-third of the category's total assets.

The upside to the fund's size is that it paved the way for a tiny 0.39% expense ratio, well below the category's 1.69% average. The downside is that Vanguard has raised the fund's minimum investment for nonretirement accounts to a hefty $10,000, to keep inflows under control.

Another diversified health care fund you might examine is (FSPHX)Fidelity Select Health Care, which levies a maximum 3% front-end load, or sales charge. The fund has had three different managers in three years, keeping it off our list, but frequent manager changes are the norm on Fidelity's Select sector funds.

If you're looking for geographic diversification, which Merrill Lynch's Schreiber says is a good idea, the category's best option is probably the second fund on our list, broker-sold (EMHSX)Eaton Vance Worldwide Health Sciences. Samuel Isaly, who's held the reins since 1989, typically has the biggest foreign-stock weighting in the category -- at the end of May it was 31.2%. His global approach has led to a 24.2% 10-year annualized return, which beats 90% of his peers.

If you're ready for the roller coaster that is biotech-stock investing, the best option is probably (FBIOX)Fidelity Select Biotechnology, says Putchaven.

The fund, which levies a maximum 5% sales charge, didn't make our list because of frequent manager changes. It beats just about every peer over the past three-, five-, and 10-year periods, according to Morningstar, and boasts a 121% one-year return.

Another option, (JAGLX)Janus Global Sciences, is closed to new investors, but rabid biotech fans might be smart to check out (DRBNX)Dresdner RCM Biotechnology. A pair of medical doctors, Faraz Naqvi and Michael Dauchot, took the fund over last year, and their record is impressive. Over the past year, the fund, which launched in 1997, is up 240%.

Because successfully investing in health care stocks requires a keen understanding of industry dynamics and innovations, the value of a manager with significant industry and/or portfolio-management experience might be even more important in this category than in others, Putchaven says.

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