It has been a tough year for health care funds, and John Kerry's rising poll numbers certainly aren't dulling the pain.
But with the end of election season in sight, investors are increasingly divided on whether it's time to pull the plug on these funds. Some expect further setbacks for the group, especially if Democratic presidential nominee Kerry wins three weeks from tomorrow. On the other hand, plenty of observers think health stocks and funds have suffered enough to make them worth holding -- at least the better names.
Health care funds have lost an average of 1.2% over the past three months -- making them the second sorriest fund category after bear funds, which are down 4.1%. The recent catastrophes in
, over its Vioxx recall, and
, over its flu-shot shutdown, obviously have not helped the diagnosis for health care stocks, which have spent most of the year bedridden. Health care funds have returned just 2% this year -- half the return of the
There is little doubt among analysts that the election-year spotlight placed on the nation's health care system has effectively caused investors to flee health care funds. Drug stocks, which make up 40% to 60% of health care funds, have been especially hard hit this year, muting relatively strong performances in other groups such as medical device manufacturers and health maintenance organizations. And there is even less of a question as to which candidate would be worse for the group when the world wakes up on Nov. 3.
"The danger to the pharma industry is if John Kerry wins the presidency," says Jordan Schreiber, portfolio manager for the $594 million
Merrill Lynch Healthcare fund. "His policies would hurt the profitability of drug companies."
Schreiber is referring to Kerry's campaign promises to reduce prescription drug prices and perhaps allow the reimportation of drugs from Canada.
Nevertheless, Schreiber and many other portfolio managers say that no matter which side wins the election, there will be a sense of relief for health care stocks, just because some of the political bashing will end. That means the sector could be setting up for a post-election rally, just to let off steam if nothing else.
"We could very well see a post-election bounce," says Teresa McRoberts, portfolio manager for the
Alger Health Sciences fund. "But people need to sit down and look at the pipelines and products again once it's all over."
Analysts are also trying to remind voters that a come-from-behind Kerry victory won't likely punish the drug manufacturers -- unless it is accompanied by the Democrats taking over the Congress.
"The reality is that if the House stays Republican, then it will be difficult for Kerry to do anything anyway," says McRoberts. She points to Hillary Clinton's fruitless attempt to change the system in the early 1990s as an example of how the best-laid political plans can bend under the weight of the nation's mountainous health care problems.
Election-year issues are not the only factors causing investors to cool on drug stocks lately. Recent collapses at high-profile names like Merck have also frightened buyers away. And that's not always a bad thing for bargain hunters.
Christopher Davis of fund tracker Morningstar confirms that health care funds have not attracted a ton of flows lately. But he says "that may be a good contrarian indicator," while adding that "of course, that case could have been made last year, or the year before."
Merrill's Schreiber, who has been managing the fund for over 20 years, says the latest round of drug recalls and failed clinical studies should not disturb investors, since these are regular pitfalls when it comes to buying pharmaceutical stocks. Instead, Schreiber is dismayed by the poor "flow" of new drugs, meaning patent expiration exceeding new product introduction.
Schreiber says he is countering this trend by increasing his fund's holdings in overseas companies like Swiss-based
, where the flow is stronger in the other direction.
And Schreiber is far from alone when it comes to shopping overseas for drug stocks. Sam Isaly, portfolio manager of the
Eaton Vance Worldwide Health Sciences fund, says close to 30% of his holdings are in foreign companies -- a position he is prepared to increase if a Democratic victory in November puts an undue squeeze on American manufacturers.
"If the going gets tough here, we will get out," says Isaly.
Aside from looking overseas, portfolio managers are also increasing their exposure to biotechs, which typically receive a great deal of attention each fall as medical studies are revealed at conferences.
Alger's McRoberts, whose fund is ahead of the S&P index by over 3.5 percentage points this year after an impressive 41.3% return in 2003, says this autumn has the potential to be extra special for biotech-heavy funds, because of the expected approval of a handful of prominent new drugs by year-end. Those new drugs include
cancer treatment drug Tarceva, a joint project with
; Macugen, a drug created by a joint venture between
and designed to fight vision loss in the elderly; and a new drug from
called Estorra that combats insomnia.
Outside the world of drugs, McRoberts likes medical-device makers such as
St. Jude Medical
. She says these shares have come down in valuation from earlier this year, but that hasn't been enough for Schreiber, who still calls the group pricey.
On the service side,
Janus Global Life Sciences fund manager Thomas Malley says he is overweighting HMOs, a group he finds relatively cheap. Among Malley's favorites are
Coventry Health Care
Analysts also say HMOs are an area where Kerry could not do much damage, and that once again brings us back to Kerry and the election.
So how bad could a Kerry victory be for health care funds compared with where we are now?
"Most of the downside of a Kerry win is priced into the drugs already," says McRoberts.
Or, medically speaking, it can't get much worse.