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Consider Adding Health Care To Your Winning Allocation: And The ETF To Do It

Summary Supplementing your core ETF portfolio with smart sector bets can lead to healthy returns. Powerful demographic and related trends make health care one such sector, and now may be a good time to get in. However, there are risks. A quality ETF can help to mitigate these. I share my suggestion as to the one you should choose. When building your ETF portfolio, it is good to start with the basics. In my previous work on Seeking Alpha, I have suggested a simple, yet powerful and globally-diversified portfolio based on just 3 ETFs . However, you may wish to enhance such a basic approach by supplementing it with ETFs targeted at certain sectors of the marketplace. REITs are one such possibility. In a follow-up article , I built a four-ETF variant of the base portfolio that includes REITS. For this article, however, let’s take a look at another sector in which you may want to make a targeted investment. I will also suggest that you use a specific ETF to do so. Why Health Care? Why Use an ETF? In my personal portfolio, I have chosen to add a targeted investment in the health care sector. Why? Please allow me to share just a couple of quick items I found when researching this topic. We have an aging population. Consider the following, from the Administration on Aging , part of the U.S. Department of Health and Human Services: The older population-persons 65 years or older-numbered 44.7 million in 2013 (the latest year for which data is available). They represented 14.1% of the U.S. population, about one in every seven Americans. By 2060, there will be about 98 million older persons, more than twice their number in 2013. People 65+ represented 14.1% of the population in the year 2013 but are expected to grow to be 21.7% of the population by 2040. Not surprisingly, with an aging population comes increased costs for health care. Consider two excerpts from a report on aging from the Centers For Disease Control : The increased number of persons aged > 65 years will potentially lead to increased health-care costs. The health-care cost per capita for persons aged > 65 years in the United States and other developed countries is three to five times greater than the cost for persons aged 65 years ($12,100), but other developed countries also spent substantial amounts per person aged > 65 years, ranging from approximately $3,600 in the United Kingdom to approximately $6,800 in Canada ( 13 ). However, the extent of spending increases will depend on other factors in addition to aging ( 12 ). The median age of the world’s population is increasing because of a decline in fertility and a 20-year increase in the average life span during the second half of the 20th century ( 1 ). These factors, combined with elevated fertility in many countries during the 2 decades after World War II (i.e., the “Baby Boom”), will result in increased numbers of persons aged > 65 years during 2010–2030 ( 2 ). Worldwide, the average life span is expected to extend another 10 years by 2050 ( 1 ). The growing number of older adults increases demands on the public health system and on medical and social services. Chronic diseases, which affect older adults disproportionately, contribute to disability, diminish quality of life, and increased health- and long-term-care costs. In summary, the reports reveal that, due to longer life spans, people often live longer with chronic disease. Sadly, factors such as obesity and diabetes, more and more common in our culture, also lead to greater need for medications and other health care support. Finally, technological advances are making possible the treatment of certain conditions that simply could not have been treated in the past Certainly, factors such as these bode well for the long-term outlook for health-care related products and services. At the same time, investment in the health care sector is not without its risks. For example, pharmaceutical companies must spend vast amounts on R&D to develop and bring new drugs to market. But getting a drug to market is no small task. To begin with, it is a real challenge to identify and develop new chemical compounds for such drugs. And even once a potential drug is developed, it must go through rigorous clinical trials before it is approved for sale to the public. Needless to say, not all drugs make it through this process. This is where the ability to use an ETF to invest in health care can be, well, good for your investment health. I will get into the specifics of our focus ETF as it relates to this matter in just a little bit. Why Now? I have been hoping to write an article on this topic for some time. Why did I choose to do so now? The impetus actually came from this news item right here on Seeking Alpha. I won’t bother recapping it; it is short and you can read it for yourself. But here is a picture that will make very evident what the quoted analyst was getting at. VHT data by YCharts The blue line represents the Vanguard Health Care ETF (NYSEARCA: VHT ), the focus of our article. The yellow line represents the broader S&P 500 index. As can be seen, there was a roughly 12% gap between the performance of this index and the S&P 500 just a little earlier this year. Due in large part to recent concerns having to do with the biotech sector, that YTD gap has narrowed to a mere 1.2%. As the quoted analyst suggests, this may offer a good opportunity to either enter, or add to your position in, this sector. The Power of VHT Earlier, I briefly touched on some of the risks involved in investing in the health care sector and suggested using an ETF to mitigate such risk. Simply put, this is because a well-chosen ETF will allow you to remain well diversified, thus lessening single-company risk. As alluded to earlier, in this article I chose to focus on the Vanguard Health Care ETF. This ETF is based on the MCSI US Investable Market Health Care 25/50 Index . Let’s start with a closer look at that index, in the below picture taken from the factsheet for the index. (click to enlarge) Here are a few things worthy of note: There are 349 constituents, or companies, in the index. The Top-10 holdings comprise some 44.96% of the overall index, and are mostly large-cap pharmaceutical companies. This is also reflected in the overall 36.58% weighting of pharmaceuticals in the index (see pie chart). However, this risk is somewhat balanced by the inclusion of McKesson Corp. (NYSE: MCK ) and similar companies involved in the distribution of health care products, and UnitedHealth Group (NYSE: UNH ) and similar companies involved in healthcare services. This diversifies your risk, as the pie chart shows, across various sub-industries within the overall health sector. If you look at the Portfolio and Management tab of the factsheet for VHT, you will notice that this ETF is extremely faithful in tracking this index. Vanguard supplements this with a rock-bottom expense ratio of .12%. The fund’s total net assets of $6.1 billion and average daily trading volume of $58.37 million mean that the fund is extremely liquid, leading to a low .07% trading spread (the average difference between “buy” and “sell” transactions). I would hope you hold this ETF for the long term, but the above figures will hold you in good stead should you need to trade. Finally, VHT carries a 1.45% distribution yield, which Vanguard recently shifted from being an annual distribution to a quarterly distribution, which I really love. Summary and Conclusion I believe health care is a great sector in which to make a targeted investment. In this article, I have recommended using an ETF to do so, and featured the Vanguard Health Care ETF as what I believe to be your best tool to do so. This excellent choice gives you tremendous diversity across the sector, coupled with a low expense ratio and great liquidity. Happy investing!

Hedging For The Next Market Correction: 5 Winning Investments And 5 Surprising Losers

Summary More market correction indicators are incoming. One method of hedging against a market correction is in choosing ETFs uncorrelated to the market. Here, we look at 10 investments that should be good hedges. Five emerge as winners while five more emerge as losers. (click to enlarge) As I run an “at least weekly” newsletter about hedging against bear markets , market corrections, and market crashes, I am often watching the leading indicators that might imply such an event in the future. My partner at Stock Barometer, Jay DeVincentis, recently sent me an email explaining that he has seen data from the ECRI and infers another correction a la last August, as in the chart above. I have also seen the bearish leading indicators on the rise through my own record. For instance, we’ve recently seen a drop in retail sales, PPI, industrial production, and job openings. I’m not exactly 100% with Jay here because from a seasonal viewpoint, we are approaching a time at which stocks tend to enter a bull market (e.g., November of a pre-election year). As you can see from the chart above, we only recently have recovered from the last correction. Some might say we still haven’t fully recovered. In a way, I wanted to wait to write this article, but the truth is: knowing this earlier is better than later. Overall, we falling economic leading indicators, weak money flow, and higher volatility, the more conservative of us should reconsider the method of hedging used in our portfolio allocation. Though the standard of “diversification” varies across investors, one rather “solid” method of choose stocks to use as hedging vehicles is tracking the correlations of said stocks to the market as a whole. In this article, I’m doing this for you, pointing out the winners as well as some stocks that many would think are winners but are actually not. Now, you just saw me mention “correlation,” which can be interpreted in several ways. In this article, my definition of correlation is – while still a objective statistical number – the variability that market movements can explained for a given stock’s variability. When I refer to a stock “uncorrelated” to the overall market, I’m using correlations of 0 to 0.3. I am purposefully ignoring negatively correlations because the purpose of this article is to inform you of some safe investments during the wait for a bear market , not investments that will fall during a bull market yet rise during a bear market. With the correlation cutoff points I’ve chosen, statistically, general market changes can only account for 10% or less of the variation in the investments I mention below that are “uncorrelated” to the general market. The other investments I mention – those that seem as if they should be uncorrelated to the market but are really not – move in ways explainable by the market to an extent of 10% to 40%. We are looking to build a portfolio – or at least section of a portfolio – that is hedged against a market correction similar to that in the graph above. For this reason, I pored over a large selection of investments, mainly tracking indices and ETFs against the S&P 500 during the period of the last market correction, using August 18 as the starting date because that was when the volume shows the beginning of the selling. What follows are winners and close-calls. Note that some of the following will seem like common sense. However, you are likely to find a few surprises. Unless otherwise mentioned, true prices or direct indexes were used to calculate correlations (e.g., the correlation with gold was calculated with historic gold prices and the correlation with treasury bonds was calculated with the ^TYX index, whereas that with municipal bond prices was calculated with the MUNI ETF and recalculated with other municipal bond ETFs to ensure the correlation). Read on: Winners Gold. Gold is falling, yes, and it might be coming back, yes… but that’s not the point here. Gold overall was uncorrelated to the market during the last market correction. Gold is still a good hedge today, even if you’re not sure where it’s headed. Invest in: the SPDR Gold Trust ETF (NYSEARCA: GLD ) or the iShares Gold Trust ETF (NYSEARCA: IAU ). Municipal Bonds: Municipal bonds often come with the benefit of allowing you to hedge against inflation (and market corrections, of course) without having to deal with federal income tax. Local governments (e.g., states) issue these bonds to fund long-term projects such as the construction of hospitals and roads. The interest rates and open interest in these instruments are unlikely to change during a market correction, and ETFs of municipal bonds seem to hold their value quite well during a bear market. This correlation was calculated using MUNI as a proxy. Invest in: the PIMCO Intermediate Municipal Bond Strategy (NYSEARCA: MUNI ) or the Market Vectors High-Yield Municipal Index ETF (NYSEARCA: HYD ) Mexican Airports: Yes, it’s weird that I’d mention this as a general area fit for hedging against a market correction, but I came across a specific stock perhaps mislabeled as an ETF. I looked into it in the same way and found it to be uncorrelated to the market during the most recent correction. The name of the stock is Grupo Aeroportuario del Pacifico (NYSE: PAC ). In a sense, it really is an ETF on Mexican airports because this company essentially owns a monopoly on airport management and development throughout Mexico. While it has a market cap of nearly $6 billion, fewer than 600 Seeking Alpha readers hold it in their portfolios. This correlation was calculated with PAC directly. Invest in: Grupo Aeroportuario del Pacifico Treasury Bonds: You can buy a treasury bond with denominations starting at $1,000. This makes them available to virtually every type of investor. Every six months, you gain a fixed interest rate. The maturity of a treasury bond tends to be long: sitting at 30 years. These long-term investments are uncorrelated with the market and stayed strong during the recent market crash. You can also gain exposure to these bonds through ETFs, such as the one I mention below. Invest in: the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ). Biotechnology: Strange right? Biotech stocks tend to trade on NASDAQ, which is even more volatile than the NYSE. We typically think of biotech stocks being great growth stocks during a strong economy and underperformers when the economy is hurting. But the success of the biotech industry relies more on innovation than the economy, it would appear, as per the low correlations I found. That is to say, perhaps investors realize that drugs will always be needed, even when people are afraid of spending money during a recession. The market correction didn’t seem to hurt the biotech industry much. The following ETF tracks this industry and showed to be uncorrelated with the general market during the recent correction. This correlation was calculated with IBB as a proxy. Invest in: the iShares NASDAQ Biotechnology ETF (NASDAQ: IBB ) Close Calls Here are the investments that you’d think would perform much like the investments above. I am probably not the only one surprised to find that these following investments followed the market to considerable extent during the last correction. Intermediate-Term and Short-Term Bonds: You would think that most bonds move in a similar fashion during a market correction, despite the maturity of the bond. Well, you’d be wrong. I found investment-grade bonds with shorter maturities falling during the last market correction. These bonds won’t keep you safe if we see a repeat of the August fiasco. These correlations were calculated with the ETFs as proxies. Avoid: The PIMCO Total Return ETF (NYSEARCA: BOND ) and the iShares 10+ Year Credit Bond ETF (NYSEARCA: CLY ) Base Metals: Unlike gold, base metals such as aluminum, copper, and zinc were correlated with the recent market dip. If you’re looking to invest in metals but want to avoid the falling gold and silver markets, you’re barking up the wrong tree with base metals. Avoid these. Avoid: The PowerShares DB Base Metals ETF (NYSEARCA: DBB ) Crude Oil: Yes, oil seems to be doing its own thing these days. Oil is a complex beast affected by international events and seems to have hit a bottom. But still, oil was correlated with last quarter’s market slump. So if we hit another correction and you’re thinking of “buying oil at a low,” think again. At least wait until the economy is looking up to dip your hands into oil. Avoid: The United States 12 Month Oil ETF, LP (NYSEARCA: USL ) Emerging Markets Debt: Another bond category that betrays common sense is that of emerging market debt. Though at this point in history, all stock markets are correlated to an extent, you would think foreign bonds wouldn’t have fallen the dive the US stock market took. But you’d be wrong. Bonds from emerging markets fell as well. Some investors use emerging market bonds – which tend to be more risky than US bonds for obvious reasons – as low-risk investments because they believe that bonds issued by foreign countries are uncorrelated to the US market. The recent correction shows this strategy to be incorrect. This correlation was calculated with PCY as a proxy. Avoid: The PowerShares Emerging Markets Sovereign Debt Portfolio ETF (NYSEARCA: PCY ) Corporate Bonds: Bonds issued by corporations are often looked upon as safe, especially those that are of investment grade. For hedging while still retaining aggressive growth, many investors choose these bonds over government-issued bonds because of the higher yield rate. The common believe in the investment community is that junk-grade corporate bonds correlate with the market and shouldn’t be used for hedging but that long-term investment-grade corporate bonds are perfectly fine for hedging. I found this to be false, with corporate bonds falling during the recent correction. This correlation was calculated with VCLT as a proxy. Avoid: The Vanguard Long-Term Corporate Bond Index ETF (NASDAQ: VCLT ) Example Portfolios and Their Performances So what would happen if we took these two lists and made from them two portfolios? Let’s take a look at what would have happened during the recent market correction for portfolios of the “winners” and “close calls.” And then let’s see what would happen if you built these portfolios at the beginning of the year, holding all the way to today. The Winners This portfolio consists of all the ETFs I recommended in the “Winners” section above. Again, this list is: Here is what happened during the market correction: (click to enlarge) That is, your portfolio would have trended sideways while the market itself fell 10%. And here is where you’d be if you built this portfolio at the beginning of the year: (click to enlarge) Your portfolio would have climbed 6%, while an index fund would be still recovering. The Close Calls This portfolio consists of all the ETFs we’d expect to do well in a bear market yet showed a correlation with the market during the time of the correction beginning in mid-August. This portfolio consists of all the ETFs in the “Close Calls” section above. Here is our portfolio: Here is what happened during the market correction: (click to enlarge) The close calls started dropping even before the bear market and then moved in tandem – but under – the market during the correction. And here is where you’d be if you built this portfolio at the beginning of the year: (click to enlarge) You’d still be below the market, unfortunately. I Want Your Input Obviously, I simply don’t have the time to cover every industry. While reading this article, you probably thought of at least one investment that should have gone in my “Winners” section. Let me know about it in the comments section below. Request a Statistical Study If you would like for me to run a statistical study on a specific aspect of a specific stock, commodity, or market, just request so in the comments section below. Alternatively, send me a message or email.

Best And Worst Q4’15: Health Care ETFs, Mutual Funds And Key Holdings

Summary The Health Care sector ranks ninth in Q4’15. Based on an aggregation of ratings of 23 ETFs and 61 mutual funds. IXJ is our top-rated Health Care sector ETF and FSHCX is our top-rated Health Care sector mutual fund. The Health Care sector ranks ninth out of the 10 sectors as detailed in our Q4’15 Sector Ratings for ETFs and Mutual Funds report. Last quarter , the Health Care sector ranked fifth. It gets our Dangerous rating, which is based on an aggregation of ratings of 23 ETFs and 61 mutual funds in the Health Care sector. See a recap of our Q3’15 Sector Ratings here . Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the sector. Not all Health Care sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 24 to 353). This variation creates drastically different investment implications and, therefore, ratings. Investors should not buy any Health Care ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off. Figure 1: ETFs with the Best & Worst Ratings – Top 5 (click to enlarge) * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 (click to enlarge) * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The Live Oak Health Sciences Fund (MUTF: LOGSX ) and the Saratoga Advantage Trust: Health & Biotechnology Portfolio (MUTF: SBHIX ) are excluded from Figure 2 because their total net assets (TNA) are below $100 million and do not meet our liquidity minimums. The iShares S&P Global Healthcare Index Fund ETF (NYSEARCA: IXJ ) is the top-rated Health Care ETF and the Fidelity Select Medical Delivery Portfolio (MUTF: FSHCX ) is the top-rated Health Care mutual fund. Both earn a Neutral rating. BioShares Biotechnology Products (NASDAQ: BBP ) is the worst-rated Health Care ETF and Rydex Series Biotechnology Fund (MUTF: RYBOX ) is the worst-rated Health Care mutual fund. Both earn a Very Dangerous rating. 338 stocks of the 3000+ we cover are classified as Health Care stocks. HCA Holdings (NYSE: HCA ) is one of our favorite stocks held by Health Care ETFs and mutual funds and earns our Very Attractive rating. Since 2012, HCA has grown after-tax profit ( NOPAT ) by 5% compounded annually. HCA earns an impressive top-quintile return on invested capital ( ROIC ) of 15%. This high profitability has allowed HCA to become the largest hospital operator in the world. However, HCA shares are priced as if the company will see a significant decline in profits going forward. At its current price of $69/share, HCA has a price to economic book value ( PEBV ) ratio of 0.8. This ratio implies that the market expects HCA’s NOPAT to permanently decline by 20%, in spite of the profit growth achieved the past four years. If HCA can grow NOPAT by just 5% compounded annually over the next five years , the stock is worth $123/share today – a 78% upside. Athenahealth (NASDAQ: ATHN ) is one of our least favorite stocks held by Health Care ETFs and mutual funds and was put in the Danger Zone in April 2015. Since 2011, athenahealth’s NOPAT has declined by 43% compounded annually. Over the same timeframe, ROIC has fallen from 14% to a bottom quintile 0%. The biggest issue at athenahealth remains its inability to grow the business and rein in costs. However, as we’ve seen with other Danger Zone companies, investors have overlooked athenahealth’s problems by focusing on revenue growth, which has left ATHN overvalued. To justify its current price of $149/share, athenahealth must grow NOPAT 37% compounded annually for the next 23 years . This expectation seems rather optimistic given the sustained profit decline since 2011. Figures 3 and 4 show the rating landscape of all Health Care ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst ETFs (click to enlarge) Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds (click to enlarge) Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Thaxston McKee receive no compensation to write about any specific stock, sector or theme.