NEW YORK (Fabian Capital Management) -- As a sector, health care has a lot to offer in terms of fundamental and technical data that supports ongoing innovation and profitability. The aging baby boomer population combined with an increased focus on adorable health insurance is continuing to promote a focus on new drugs and medical devices aimed to increase quality of life.
From a performance standpoint, the Health Care Select Sector SPDR (XLV) - Get Report has significantly and consistently beaten the SPDR S&P 500 ETF (SPY) - Get Report over multiple time frames. The following table illustrates the differences in average annual return of both funds over the last one, three and five years.
The current list of health care-related ETFs (excluding leverage) now stands at 25. While XLV works well as a large-cap benchmark for the health care sector, there are a number of ETFs that track a more sophisticated group of companies. These can includes: industry groups, small companies, fundamental indexes, international stocks, and a host of other categories.
Often times these unique ETFs can produce much superior returns when compared to a plain-vanilla index. Being in the right spot at the right time, such as iShares NASDAQ Biotechnology ETF (IBB) - Get Report return of 65.51% in 2013, can lead to a tremendous advantage in your portfolio.
The following funds represent areas that have had the strongest performance of the health care group in 2014. Some of which you may never have heard of before.
The Market Vectors Pharmaceutical ETF (PPH) - Get Report is the best-performing health care industry ETF with a total return of 18.29% this year. This fund invests in the 25 largest and most liquid U.S.-listed pharmaceutical companies based on market cap and trading volume. PPH charges a net expense ratio of 0.35% and has a 30-day SEC yield of 1.84%.
While 58% of the holdings in PPH are U.S.-based, a healthy exposure to stocks in Switzerland, the United Kingdom, and France has helped propel it past its peers this year. Investors in this ETF have benefitted from large jumps in Allergan (AGN) - Get Report and Novo Nordisk (NVO) - Get Report, which have gained 53% and 26% respectively.
The continued development and distribution of new drugs makes the pharmaceutical industry a bright spot in the health care industry for the foreseeable future.
While biotechnology stocks have cooled off significantly from their run last year, one ETF has continued to put up impressive results. The First Trust NYSE Arca Biotechnology Index Fund (FBT) - Get Report has over $1.2 billion invested in just 20 biotechnology companies with an equal-weighted portfolio structure.
This concentrated basket of stocks allows for each holding to contribute a proportionate share of the total performance, which has combined to generate positive returns of 17.71% this year. The stocks in FBT are rebalanced on a quarterly basis to ensure the weightings remain in line with the index specifications and the fund charges an expense ratio of 0.60%.
This focused exposure can also work against the concept of diversification that ETFs have become so famous for as well. An ETF with fewer holdings can be subject to additional volatility if one stock fails to perform with the group. However, for the time being the FBT portfolio appears to be firing on all cylinders.
The iShares U.S. Healthcare Providers ETF (IHF) - Get Report is another leading segment of the health care sector this year as well. IHF has gained 13.57% so far in 2014 and just recently hit a new all-time high. This ETF tracks 49 stocks engaged in health insurance, diagnostics, and specialized treatment.
Companies in IHF such as UnitedHealth Group (UNH) - Get Report and WellPoint (WLP) have continued to benefit from the halo effect of Obamacare along with a growing need for medical services here in the United States. IHF charges a modest 0.43% expense ratio and has over $500 million in total assets.
Historically, this fund has had less volatility than the market as a whole. According to the iShares website, IHF has a beta to the S&P 500 Index of just 0.65, which indicates smaller price fluctuations than a broad measure of stocks.
The Bottom Line
When you are researching which sector or ETF to purchase, make sure you pay close attention to the construction of the underlying index. That will have a significant impact on the performance of the fund through good times and bad. You should also note the expense ratio of the fund, as many ETFs have complementary portfolios with vast differences in annual fees.
In addition, it pays to know where the aggressive and conservative areas of each sector lie. In the case of healthcare, biotechnology is going to be characterized as a high beta industry, while healthcare providers will generally be lower in overall volatility.
At the time of publication the author had no position in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.