Until science beats death, disease and disability, the health care industry would seem a wonderful investment. Yet in 2019, it fell a bit behind the broader stock market.
Mutual funds and exchange-traded funds focused on health care returned 29 percent in 2019, according to Morningstar. That would have been laudable in most years, but it lagged the S&P 500 stock index, which returned 31.49 percent, including dividends.
Political uncertainty hasn’t helped the health care sector. The industry encompasses things as diverse as pharmaceutical and biotechnology companies, makers of laboratory equipment and providers of health insurance, and many of its companies have lately been touched by controversy.
Calls by some Democratic presidential candidates for universal public health insurance — so-called Medicare for all — and limits on drug prices, as well as continuing litigation over both the Affordable Care Act and opioid abuse, have weighed on health care stocks, even as many of the companies have thrived.
“Sometimes stocks are cheap for a reason, but health care isn’t cheap for a fundamental reason,” said Matthew J. Bartolini, head of SPDR Americas Research at State Street Global Advisors, sponsor of the Health Care Select Sector SPDR Fund. Health care companies have shown strong earnings growth, and their shares are priced reasonably, compared to other sectors’, he said. “But they’ve had this regulatory overhang.”
Earlier in 2019, when Senator Elizabeth Warren, an advocate of Medicare for all, was surging in many polls, investors fled health care stocks, said Dr. Ziad Bakri, manager of the T. Rowe Price Health Sciences Fund.
Senator Warren has “put some meat on the bones of her positions, which makes it seem like she wouldn’t be trying to eliminate private insurance from Day 1” of a Warren administration, he said. The refinement of her position may have contributed to a health care rally in the fourth quarter.
Investors in the T. Rowe Price fund gained 29.11 percent in 2019. Dr. Bakri, who worked as an emergency-room physician in Britain before moving into investment management, favors biotechnology stocks, investing about one-third of the fund’s assets in them. He said he likes them for both their growth potential and their unusual risk-reward proposition.
“Biotech stocks have less correlation with each other, compared to managed-care or oil-and-gas companies. Whether Vertex’s cystic-fibrosis drug trial succeeds has no relevance to whether Amgen’s next drug succeeds,” he said. Dr. Bakri’s fund recently owned both stocks, with Vertex Pharmaceuticals its third-largest holding at the end of November.
The diversity of the health care industry can add to its appeal. Its innovations aren’t limited to genetically engineered cancer cures.
Also promising are the digitization of medicine, through services like UnitedHealth’s Optum, a pharmacy benefit manager, and the push to make care more accessible to consumers, through outfits like CVS’s in-store MinuteClinics, said Eddie L. Yoon, manager of the Fidelity Select Health Care Portfolio. UnitedHealth was recently the Fidelity fund’s top holding.
The digitization of health care will resemble the evolution of Amazon, Mr. Yoon said. “Amazon was originally just a bookstore, but it evolved into what it is today. If you think of health care today, we’re still just at the bookstore stage.” Mr. Yoon’s fund returned 31.46 percent in 2019.
A traditional argument for betting on health care is that people need treatment regardless of the strength of the economy, and so the industry resists recessions and buffers the stock market’s ups and downs. The actual evidence is mixed, however, said Leemore S. Dafny, a health care economist and professor at Harvard Business School. Multiple studies have shown that growth in health care spending correlates strongly with the economy, she said.
One study found that, after the last recession, 70 percent of the slowdown in the growth of health care spending stemmed from the sluggish recovery. Another noted that the increased prevalence of high-deductible insurance coverage and greater cost sharing between employers and employees probably contributed to the spending slowdown’s persistence.
“That would suggest health care is not recession-proof, though it may be more so than other sectors,” Professor Dafny said. “I’d expect that to be even truer today because there’s greater consumer cost sharing.”
If investors do opt to bet on health care, they will face the perennial choice between an actively managed fund, like those overseen by Dr. Bakri of T. Rowe Price or Mr. Yoon of Fidelity, or a passively managed offering built around a sector index.
Nick Watson, a Morningstar analyst, said health care may be an area where deep knowledge can give an active manager an edge. Assessing, say, the early results of a pharmaceutical trial or the science behind a biotech company discovery often requires medical expertise. “On a health care team, when I see medical credentials, that bodes well,” he said.
The advantage for passive investing is, as ever, cost. Indexed offerings typically cost less than their actively managed counterparts.
For example, the investor shares of Vanguard’s actively managed Health Care Fund carry an expense ratio of 0.34 percent, while the shares of the company’s indexed Health Care E.T.F. carry one of 0.1 percent. The T. Rowe Price Health Sciences fund has an expense ratio of 0.77 percent, while the Fidelity Select Health Care Portfolio has one of 0.71 percent.
The challenge in picking an indexed offering is understanding the underlying index, said Ben A. Johnson, Morningstar’s director of global E.T.F. research. “What’s the universe the fund’s sweeping in — are you getting broad exposure to all things health care or is it more of a niche?”
State Street’s Health Care Select Sector SPDR holds the health care stocks in the S&P 500, which means it skews toward larger-capitalization companies, like Johnson & Johnson and Merck. In contrast, Vanguard’s E.T.F. holds about 400 stocks and includes mid- and small-cap shares.
Both funds weight their holdings by market capitalization, with larger-cap companies having more heft in the funds. In contrast, as its name indicates, Invesco’s S&P 500 Equal Weight Health Care E.T.F. holds the index’s constituents in roughly equal amounts.
Investors with broadly diversified portfolios should consider whether they need any further health care holdings, because the sector accounts for 14 percent of the S&P 500’s market capitalization, and Johnson & Johnson is one of that broad index’s top 10 constituents.
As for when politics and controversy might stop dragging on health care shares, that may not happen until after the 2020 election, said Teresa K. McRoberts, portfolio manager of the Alger Health Sciences Fund.
“A change in administration often means volatility in health care,” said Ms. McRoberts, who has overseen health care portfolios since the 1990s. “The group typically underperforms in the year before or the year of an election.”