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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!

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.

Duke Energy- Investors Do Not Like The Piedmont Deal, Nor Do I

Summary Duke Energy is expanding its natural gas operations in the Carolinas by acquiring Piedmont. Investors doubt the steep premium being offered for Piedmont, as do I. Duke has failed to quantify the anticipated earnings accretion as I think that the company´s acquisition track record is mediocre at best. The only real appeal comes from the dividend yield as earnings multiples are inflated due to the low interest rate environment. The increase in leverage makes me very cautious amidst the historical and relative steep multiples at which Duke is trading as the future of the industry is becoming more uncertain. Duke Energy ( DUK ) announced a sizable deal as the company is looking to acquire Piedmont Natural Gas ( PNY ) in a $4.9 billion cash deal. Investors in Duke balk at the high premium being offered for Piedmont´s shares, as I fail to see real appeal as well. Add to that the poor acquisition track record of Duke, an increase in leverage, and increasingly uncertain future for the regulated industry, and I am very cautious. For these reasons, shares remain a no go in my eyes as the dividend is the only appealing factor for the shares. Amidst risks to the valuation in case interest rates rise and non-compelling dividend growth, I would be very cautious. A Strategic Deal.. Duke is looking to expand its operations in the Carolinas and Tennessee as ownership of Piedmont will give the company access to a million customers in those states. Roughly 90% of these customers are residential and customer growth has averaged roughly 1.5-2% per year. These are fairly attractive growth rates in comparison to Duke which is reporting customer growth rates of around 1% per year. The increased scale and expansion of Duke´s natural gas platform are not the only reasons behind the deal. Both companies have been working together in the $5 billion Atlantic Coast Pipeline project. Piedmont has a lot of interests in other joint ventures as well including Hardy Storage, Pine Needle LNG Storage, the Cardinal pipeline and Southstar Energy Services, among others. It must be said that the vast majority of both earnings and assets are generated through Piedmont´s regulated utility business however. Besides increasing Duke´s scale, the deal allows for the expansion of its gas infrastructure platform and the transformation towards becoming a highly regulated business. Ahead of the deal, Duke generated 85% of its earnings from regulated utility operations in the Midwest, Carolinas and Florida. Roughly 10% of the earnings are generated from the international operations in Latin America as commercial wind and solar project generate the remainder of the profits. This latest deal will only increase the relative profit share of the regulated business. The company has not discussed cost or revenue synergies from the deal besides the strategic benefits. On the deal conference call , management actually admits that no synergies have been considered in the decision to pursue this deal. It must be stated that Duke has the ability to borrow cheaply. Additionally, Duke is making a large bet on continued oversupply of natural gas in North America, keeping prices low for a long time to come. This should make natural gas the preferred energy option for decades to come, at least in Duke´s opinion. This shifts the company away from coal based generation as the electricity business is suffering from lower long term demand for electricity following increased efficiency of usage. ..Comes At A Price To obtain ownership of Piedmont, Duke is willing to pay a roughly 40% premium for Piedmont´s shares. This translates into a purchase price of $60 per share. Including the $1.8 billion in debt, the deal price comes in at $6.7 billion. While this is a sizable amount, Duke expects to finance just $500 to $750 million in the form of newly issued equity with the remainder coming from additional debt. Despite the fact that the board of both companies have already agreed in favor of the deal, and Piedmont´s shareholders are likely to do the same given the fat premium offered, closing is only anticipated late in 2016. Regulatory approval is always a tedious issue in this industry, which makes that it takes more time before deals finally close. Despite the fact that Duke is paying a 40% premium, the company anticipated accretion to adjusted earnings per share in 2017. Unfortunately Duke does not quantify this anticipated accretion although it cites that the cheap cost of debt of 4% alone is sufficient to result in accretion. This is even the case if no synergies are being realized. Adding To The Long Term Targets The vast majority of Piedmont´s business is a regulated business which is allowed to earn a return on equity of 10-10.2% from its operations. Duke anticipates that the faster growth rate of Piedmont will improve the overall growth profile as it reinforces its position as the largest US utility business. The company previously anticipated that earnings will come in at $4.55 to $4.75 per share in 2015. The deal are complementing the company´s plans to grow earnings per share by 4-6% per year through 2017. Investors should like the sound of this as the company sticks to its 65-70% payout ratio, having paid dividends for 89 years in a row now. The deal actually allows the company to make a big step with its investments plans for the years 2015-2019. The company outlined a $23-$26 billion spending plan for these four years with respect to new power generation, infrastructure investments as well as compliance and other investments. By acquiring Piedmont, Duke will complete a major step with regards to its infrastructure investments. With the deal, Duke is pulling a lot of its investments forwards in time. This does have an impact, namely that the leverage position will continue to increase in the short to medium term. Duke itself operated with a net debt load of roughly $40 billion ahead of the deal as the purchase of Piedmont will increase this number to roughly $46 billion. This corresponds to pro-forma EBITDA of some $9.7 billion, for a 4.7 times leverage ratio. The Market Is Not Buying It Shares of Duke Energy have fallen some 2.5% in response to the deal, wiping out roughly $1.2 billion in shareholder value. This wealth destruction is pretty much equivalent to the $1.4 billion premium being offered for Piedmont. The skepticism of investors can be understood, even as the deal is relatively small compared to Duke´s enterprise valuation of roughly $84 billion. The negative reaction is driven by the large premium and the fact that the deal will face some uncertainty, given that Duke already has a large presence in the Carolinas. This could potentially raise some anti-trust issues down the road. Other concerns include the mediocre track record with regards to large strategic deals which Duke has made in the past. This mostly relates to the $26 billion purchase of Progress Energy back in 2012. This deal has created some problems for Duke in recent years as it made the company an owner of nuclear plants, as Duke ended up paying multi-million dollar settlements in the years following as well. Back in 2007, Duke Energy has actually spun-off gas assets into Spectra Energy (NYSE: SE ) . Ironically, it are similar kind of assets which the company is now aiming to buy back through the purchase of Piedmont. All these deals have not really paid off for investors. While pro-forma revenues of $25 billion have increased by two-thirds over the past decade, the outstanding share base has increased by 70% as well. As a matter of fact, the book value of the company and earnings per share have only moved down, so have dividends. Of course investors have received a stake in Spectrum, although that does not make up for the disappointing results. This makes that Duke´s prime attraction is the 4.6% dividend yield amidst a very modest track record. The trouble is that this yield is very attractive on a relative basis, as those looking for income have pushed up shares of ¨yield¨ plays in recent years. As a result, Duke is now trading at similar multiples as the general market. This makes shares very risky in case the interest rate environment will change and trend upwards. Add to that the increasing leverage and an increase in the uncertainty faced by the still regulated industry, and you understand why current levels do not look appealing for long term investors. This is based on my assumption that the regulated industry model will come under pressure as advancements in notably wind and energy power generation have the potential to undermine the regulated industry business model. If you combine everything you will note that this is a very dangerous situation for long term holders of the stock. While the strategic rationale behind the increased focus on gas makes sense, the premium seems very steep as much more infrastructure has gone for sale in the form of limited partnerships in the last year. The high valuation, increasing leverage, pricey deal and the long term uncertainty for the industry all outweigh the appeal of the current dividend.