It is not hyperbole to say 2013 was the year of the health care exchange trade fund. Multiple anecdotes prove the point.
Not only was the Health Care Select Sector SPDR (NYSEArca: XLV) the second-best of the nine sector SPDRs, but four biotechnology funds were among 2013’s 10 best non-leveraged ETFs. The strength has carried into 2014 as three biotech ETFs are among this year’s 10 best ETFs and XLV is already up nearly 3% while the S&P 500 has traded lower. [The Best ETF for Biotech Takeover Targets]
“We attribute the recent strength to a number of factors, most notably to a winding down of the unprecedented wave of patent expirations sustained in 2012, resurgence in new product launches and positive developments on the R&D front,” said S&P Capital IQ in a recent research note.
The research firm is generally bullish on the health care sector, although “average P/Es in the drug sector have come up over the past 12 months, with multiples based on 2013 projections for normalized EPS averaging near 14X, closer to market multiples,” according to S&P Capital IQ.
In terms of individual stocks, S&P has a five-star rating on biotech giant Gilead Sciences (NasdaqGM: GILD). Gilead, a major holding in ETFs such as the iShares Nasdaq Biotechnology ETF (NasdaqGS: IBB) and the Market Vectors Biotech ETF (NYSEArca: BBH), is up more than 7% to 2014 and a touched a new all-time high Tuesday.
S&P Capital IQ also has four-star ratings on Dow components Merck (NYSE: MRK) and Pfizer (NYSE: PFE).
“Pharma dividends are highly attractive, in our view, with average yields ranging in the 3%-5% area. We believe strong cash flow generation should provide support for dividends, which remain a high investor priority,” said S&P in the note. “Pharmaceutical companies over the past five years have embarked on a number of strategies aimed at rejuvenating long-term growth. These strategies have included aggressive pricing, especially in specialty drugs; increased emphasis in expanding in rapidly growing emerging markets; and aggressive cost streamlining measures. Many large players, such as Merck and Pfizer, are also propping up their stocks and augmenting EPS through aggressive stock repurchase programs.”
S&P also has a four-star rating on AbbVie (NYSE: ABBV) and three-star ratings on Bristol-Myers Squibb (NYSE: BMY) and Eli Lilly (NYSE: LLY). Pfizer, Merck, Abbvie and Bristol-Myers combine for almost 24% of XLV’s weight. S&P rates the largest health care ETF by assets overweight. [Two Sector ETFs That Should Rise in January]
The rival iShares U.S. Healthcare ETF (NYSEArca: IYH) is also rated overweight by S&P Capital IQ. The aforementioned, excluding Eli Lilly, stocks are all top-seven holdings in IYH, combing for over 26% of the $1.99 billion ETF’s weight.
Investors looking for more focused pharma exposure can opt for an ETF such as the iShares U.S. Pharmaceuticals ETF (NYSEArca: IHE), which also garnered an overweight rating from S&P. Pfizer, Merck, Bristol-Myers and Lily are IHE’s second- through fifth-largest holdings, respectively, combining for nearly 32% of the fund’s weight.
The SPDR Pharmaceuticals ETF (NYSEArca: XPH) is more of an equal-weight spin on the pharmaceuticals sub-sector as it veers away from heavy allocations to blue-chip large-caps in an effort to integrate mid- and small-cap growth names.
S&P rates XPH marketweight, the same rating it bestowed on the PowerShares Dynamic Pharmaceuticals Portfolio (NYSEArca: PJP). PJP is smart-beta play on pharma stocks as its 29 holdings are selected based on price momentum, earnings momentum, quality, management action, and value. Bristol-Myers, Gilead, Merck and Pfizer combine for 19.2% of PJP’s weight. [Politics Could Lift Pharma ETFs]
While biotech and broader health care ETFs often command more attention than their pharma-focused peers, pharma funds have outpaced broader health care ETFs to start 2014. For example, XLV and IYH are up an average of 3.2% while IHE, PJP and XPH are higher by an average of 5.3%.
SPDR Pharmaceuticals ETF
Tom Lydon’s clients own shares of Pfizer.