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Health Care Fund Loses 'Defensive' Quality

A big underperformance compared with the S&P 500 suggests it's either a bargain or a value trap.

It has been anything but a year of wellness for health care providers.

The

iShares Dow Jones U.S. Healthcare Provider Fund

(IHF)

has fallen 47% so far this year, more than the

S&P 500's

32% decline.

The ETF returned 18.3% in 2007 vs. 5.5% for the S&P 500. The underperformance was unexpected in 2008, in light of the fact that many investors sought out less-risky asset classes as the year unfolded. Historically, an investment in health care would have sounded like a good place to be, given its defensive nature. This notion has proven to be anything but the case.

IHF, whose top holdings include

UnitedHealth Group

(UNH)

,

WellPoint

(WLP)

,

Medco Health Solutions

(MHS)

,

Aetna

(AET)

and

Humana

(HUM)

, ran into trouble early on in 2008.

In March, WellPoint slashed its full-year forecast due to higher-than-expected medical costs. Humana followed the lead two days later while blaming revised projections on the performance of its Medicare Part D plan. In April, UnitedHealth continued the trend when it reported its first-quarter results. Unusually high influenza costs and a decline in membership for its risk-based commercial markets products were cited as contributing factors to a downward revision in its full-year outlook.

IHF's slide raises the issue as to whether the ETF is a bargain or value trap. It's now trading at $39, down from its 2008 high of $64.

"We put a 'sell' rating on it when it broke below $59 in January," said Philip Yockey, president and chief investment officer of

Tactical Analytics

, an independent private research company. "Right now you are at a price that you only see 5% of the time. Either it's cheap or something has fundamentally changed."

Eric Aanes, president of Titus Wealth Management, concurs with Yockey that valuations in the sector have improved. "Health care is a good defensive play," he said. "It has been long overdue and valuations are attractive in the sector."

Aanes prefers some of the large-cap pharmaceutical companies over health care providers, including

Pfizer

(PFE)

. "The stock has a good dividend yield that is now in excess of 7% and the company has a strong balance sheet," he said.

Aanes also likes drug manufacturer

Teva Pharmaceutical Industries

(TEVA)

. In late July, Teva reported second-quarter results that included a 3% increase in EPS on an 18% spike in net sales vs. a year earlier. The company benefited from new product launches in the U.S. and strong international sales growth.

Paul Alan Davis, a manager of the

Schwab Health Care Fund

(SWHFX)

, says that relative to other sectors, health care should be a safer area of the market at least until mid-2009. The manager, whose fund has fallen 30% this year, is underweight in managed-care companies. SWHFX has outperformed 92% of its peers over the past five years.

Two positions in the space that Davis has held on to are Aetna and

Cigna

(CI)

. "Their fundamentals are showing the ability to generate strong cash flows," he said. "Both companies are repurchasing shares and have done a good job with the timing of their repurchases."

The focus on fighting rising medical costs is a trend that has led to opportunities for Davis. Two of his top 25 holdings that also play a prominent role in IHF include Medco Health Solutions and

Express Scripts

(ESRX)

. "We are continuing to hold pharmacy benefit managers," he said. "Being involved in medical-cost containment, they are positioned for increased positive attention."