Rx for Vanguard Health Care Withdrawal

Now that the most popular health care fund is closed, we look at some alternatives in the sector.
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Boohoo. Vanguard's highflying $10 billion

(VGHCX) - Get Report

Health Care fund closed

last week to new investors. But that doesn't mean there's nowhere else to turn if you're determined to invest in the sector.

In fact, there is a wide array of choices;

Lipper

tracks at least 28 health and biotechnology funds. But just because they're in the same category doesn't mean they're all the same.

"There are a lot of different kinds of health care," says Kirsten Hudson, an analyst at the

Value Line Mutual Fund Survey

. "There are funds that invest in biotech and big pharmaceuticals and funds that invest in managed care. And all of those sectors tend to perform very differently."

That's apparent when looking at the returns of the best- and worst-performing funds in Lipper's health and biotechnology category. Over the last 12 months, the best-performing fund in the sector, the $750 million

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Fidelity Select Biotechnology fund, returned 27.1%. But the worst fund, the $114 million

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Fidelity Select Medical Delivery fund, was a near mirror image with a return of negative 28.8%.

Lately, the hot health-care sector has been pharmaceuticals. Vanguard Health Care had a 48% weighting in drug stocks in January, and that was reflected in its 40.8% return for 1998. The cold sector has been health-maintenance organizations, or HMOs, the companies in which Fidelity Select Medical Delivery has been concentrating. So-called global health-care funds and funds that invest heavily in biotech have seen mixed results.

Before you buy, be sure you know what kind of health care your fund invests in.

"Of the four or five sectors of health care, the only one you're making money in is pharmaceuticals," says Al Blomquist, a financial adviser in Franklin Lakes, N.J. "It's the Pentium chip of the health-care industry."

Now that Vanguard is closed to new investors, Blomquist likes the $1.7 billion

Invesco Health Sciences fund, run by John Schroer.

That fund returned 43.4% in 1998, the best of any health-care fund tracked by Lipper. And it's no wonder -- nearly 60% of its assets are in pharmaceutical companies. But pharmaceuticals have risen so much in recent years that some fund watchers think they now may be overvalued.

That's not Schroer's thinking, though. He says there's plenty of life left in the sector.

"Over time, these names will outperform the market," Schroer says. He notes that a "terrific" product cycle that started two or three years ago for the big drug companies, such as

Pfizer

(PFE) - Get Report

and

Merck

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, will continue to expand as the country's population gets older.

"It's the baby boomers," he says. As the me generation gets older, baby boomers will need "chronic drugs" for conditions such as high cholesterol for a very long time to come. "These are drugs that you take for the rest or your life," he says.

Schroer's fund has a 20% to 25% allocation in med-tech companies, such as pacemaker manufacturers

Medtronic

(MDT) - Get Report

and

Guidant

(GDT)

, and single-digit allocations to biotech and services companies, with a small reserve of cash.

One diversified health-care fund Hudson likes is

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Putnam Health Sciences, managed by Richard B. England.

"Management steered the fund away from biotech and heath-science companies last year" and into pharmaceuticals, which helped the fund's returns. "On the other hand," Hudson says, "biotech later in the year did very well."

You can see that in the returns of the $97 million

(ETHSX) - Get Report

Eaton Vance Worldwide Health Sciences fund, which invests in biotech concerns like antibody developer

Centocor

(CNTO)

.

As biotech picked up the pace in the fourth quarter of 1998, so did this fund, with a 27.2% return during that period. But for 1998 as a whole, it scored a less impressive 23.5% return, below the 28.6% return of the

S&P 500

.

But this fund is different from most others in the health-care sector because its not dramatically overweighted in pharmaceuticals, which constitute only about 30% of assets. That means it could fare well if the other funds in this sector head south. And it pursues companies outside the U.S., which allows it to scour places like Europe for new opportunities and fresh markets when things dry up at home.

With about 40% of the fund's assets outside of the U.S., manager Sam Isaly says he casts a wide net looking for new technology and opportunities. "We believe technology exists everywhere and that opportunity exists everywhere," Isaly says. "We're prepared to take them wherever they lie."

The fund has about 15% of its assets in Europe and 5% in private equity companies. While the fund hasn't been at the top of its heap lately, over five years, it has returned a respectable 18.8% annually.

The fund's largest U.S. holding is

Monsanto

(MTC) - Get Report

, which Isaly likes because of his bullish outlook for the introduction of

Celebrex

, the company's new arthritis drug.

"We don't change our style to match the market fads," Isaly says. "We believe the market will come our way."

Looking at long-term performance, there's one fund in the sector that stands tall above the rest: the $3 billion

(FSPHX) - Get Report

Fidelity Select Health Care fund. The fund, which has a one-year return of 26.6%, is the top-performing health-care fund tracked by Lipper for three, five and 10 years. Its 10-year annualized return is an impressive 25.6%. Not surprisingly, it's heavy on pharmaceuticals.

Yet some might say that fund also has its disadvantages -- in the form of a 3% front-end load.

"If you pay the 3% load to get into the

Fidelity Select funds, they're super," Blomquist says. But he also notes these funds tend to "slice" health care into increasingly smaller and smaller slices -- like the low-performing Fidelity Select Medical Delivery.

"There's nothing wrong with it," Blomquist says about that philosophy. "As long as you've got the right slice."