Best 3 Healthcare ETFs to Invest in 2017
What Are the Best Healthcare ETFs for 2017?
Regular readers of Income Investors would know that we are big fans of exchange-traded funds, or ETFs. We recently looked at the top dividend ETFs for 2017 and the best small-cap ETFs. Now, it’s time to check out the best healthcare ETFs.
The healthcare sector deserves special attention from long-term investors. This is in part due to a key demographic trend. According to the U.S. Census Bureau, the number of Americans aged 65 and over is expected to nearly double by 2050. An aging population could become a huge catalyst for healthcare companies in the U.S. (Source: “An Aging Nation: The Older Population in the United States,” U.S. Census Bureau, last accessed July 12, 2017.)
Furthermore, many industries within the healthcare sector are known to be recession-proof. When our economy enters a downturn, new car sales may be down, but the demand for healthcare products and services tends to stay steady, as these are necessities rather than luxuries.
Why Buy Healthcare ETFs?
Like all exchange-traded funds, a healthcare ETF usually holds multiple stocks in the healthcare sector. Therefore, one of the most obvious benefits of investing in healthcare ETFs is that they provide diversification. As we know, while the healthcare sector can provide great growth potential, certain healthcare companies do carry a sizable amount of risk. For instance, unless you treat the stock market like a casino, it’s probably not a good idea to put all your money in a biotech startup whose future relies on the outcome of certain clinical trials.
Healthcare ETFs can help investors diversify their exposure to the sector at a relatively low cost. Some of today’s discount brokerages allow investors to buy and sell shares at less than $10.00 per transaction. However, when you are buying a few dozen stocks at a time, transaction costs quickly add up. With a healthcare ETF, an investor can have a portfolio of tens, and sometimes hundreds, of companies with one simple transaction.
But of course, in return for providing convenience, healthcare ETFs charge a management fee. So for income investors considering healthcare ETFs, it’s important to not only look at their holdings and yield, but also take into account the annual management expense ratio.
In addition, exchange-traded funds probably offer the easiest way for novice investors to get started in the health care sector. The sector is made up of different industries. And each industry is affected by a unique set of variables. For someone with no experience investing in the sector, it would take a lot of time and effort to understand a specific company’s business. For instance, if an investor is considering a drug company, they would need to understand the underlying condition, what drugs are already available to treat that condition, how many people are affected, patents, the availability of substitutes, the clinical trial process required by the FDA, just to name a few.
In other words, without industry-specific knowledge, it would be difficult to become an expert in healthcare stocks. Fortunately, healthcare ETFs usually track an index. These indices are usually maintained by professionals, with their constituents updated on a regular basis. At the very least, investing in the best healthcare sector ETFs could give investors a piece of mind. With a portfolio of stocks, there is less need to worry about company-specific news.
That being said, not all healthcare ETFs are the same. Some of them are diversified across many different industries, while others focus exclusively on one particular industry within the healthcare sector. For instance, a pharmaceutical ETF usually has dedicated exposure to pharmaceutical stocks, whereas a medical device ETF is usually made up of companies that manufacture, distribute, and sell medical devices.
Best Healthcare REIT ETFs
One thing you’ll notice about a lot of the healthcare ETFs is that they don’t really yield that much. And that’s mostly due to the nature of many healthcare companies’ business. For instance, biotech and pharmaceutical companies often have to spend a lot of money on research and development every year. As a result, they have limited capacity when it comes to paying a dividend. Because dividends are supposed to be sticky, companies typically don’t want to raise their payout to levels that are unsustainable in the long run.
The consequence is that a lot of the returns of healthcare stocks come from share price appreciation rather than dividends. For healthcare ETFs holdings these healthcare stocks, it’s no surprise that their returns are driven by capital gains as well.
This means for investors looking to generate a steady stream of income from their dividend portfolios, traditional healthcare ETFs may not be enough. However, that doesn’t mean you can’t earn a regular income for healthcare industries. In fact, there is one unique type of stock that is known for providing solid dividends: healthcare real estate investment trusts, or healthcare REITs.
Income investors are well familiar with real estate investment trusts. For many REITs, the main business is leasing out properties. Because of their stable and predictable rental income, REITs can be great income investments. What’s more is that in the U.S., REITs are required by law to distribute 90% of their taxable income every year to shareholders in the form of dividends. In return, REITs don’t have to pay tax at the corporate level. In fact, due to their stable business and mandatory distribution requirements, some real estate investment trusts have been paying oversized dividends for decades.
How does this have anything to do with healthcare?
Well, hospitals, medical offices, and nursing homes take up space. Healthcare REITs own a lot these space and lease them to healthcare operators, usually over long term contracts. Even though some healthcare REITs are not directly involved in the healthcare industry, they can get paid millions of dollars in rent every year from healthcare operators. Moreover, further growth in the healthcare sector could translate to steady and increasing rental income for healthcare REITs.
There are plenty of exchange-traded funds that specialize in real estate investment trusts, but only one focuses exclusively on healthcare REITs. I have included this ETF in the list below.
Now, let’s take a look at the three best healthcare ETFs for 2017.
3 Best Healthcare ETFs List
|ETF Name||Stock Exchange||ETF Symbol||Management Expense Ratio (MER)|
|Health Care Select Sector SPDR Fund||NYSEARCA||XLV||0.14%|
|Vanguard Health Care ETF||NYSEARCA||VHT||0.10%|
|The Long-Term Care ETF||NASDAQ||OLD||0.50%|
1. Health Care Select Sector SPDR Fund
Investors looking for a diversified portfolio of healthcare stocks should consider Health Care Select Sector SPDR Fund (NYSEARCA:XLV). This ETF began trading in December 1998, making it the oldest fund of its kind. Commanding a market capitalization of $17.8 billion, it is also by far the largest fund in the segment.
XLV ETF aims to track the performance of the Health Care Select Sector Index. The index represents the health care sector of the S&P 500. This fund is no pure play pharmaceutical ETF or medical device ETF, but it contains companies from both industries. In fact, like the underlying index, XLV’s holdings come from six different industries: pharmaceuticals (34.59%), biotechnology (20.44%), health care providers and services (19.88%), health care equipment & supplies (19.41%), life sciences tools and services (5.04%), and health care technology (0.64%). (Source: “Health Care Select Sector SPDR Fund,” State Street Global Advisors, last accessed July 12, 2017.)
Note that because XLV’s holdings come from the S&P 500, it only includes the most established companies of the healthcare sector. For income investors, this could be a good thing, as the more established healthcare companies tend to have more stable cash flows.
Also, because the underlying index’s components are weighted by floating-adjusted market cap, XLV ETF is heavily weighted toward the largest healthcare companies. Right now, the fund’s top three holdings are Johnson & Johnson (NYSE:JNJ), Pfizer Inc. (NYSE:PFE), and UnitedHealth Group Inc (NYSE:UNH).
XLV ETF makes quarterly distributions to investors with an annual dividend yield of 1.82%. The fund has a management expense ratio of 0.14%.
2. Vanguard Health Care ETF
Vanguard Health Care ETF (NYSEARCA:VHT) is another well-diversified healthcare fund. It aims to track the investment results of the MSCI U.S. IMI Health Care 25/50 Index. The main difference between VHT ETF and the previously mentioned XLV ETF is that the Vanguard fund allows investors to own not just large cap health care companies, but also small- and mid-cap ones as well.
In typical Vanguard fashion, VHT ETF gives investors exposure to a large number of stocks at a very low cost. Right now, the fund holds shares of 365 healthcare stocks and has total net assets of $7.1 billion. The ETF boasts and annual expense ratio of just 0.1%, which is 92% lower than the average expense ratio of ETFs with similar holdings.
Vanguard Health Care ETF pays quarterly dividends and is yielding 1.35% at today’s price. In the past 10 years, the fund has delivered average annual return of 11.13%.
3. The Long-Term Care ETF
The Long-Term Care ETF (NASDAQ:OLD) is the healthcare REIT ETF I talked about earlier. In fact, OLD is the only healthcare REIT pure play in the ETF world. So for investors looking for the best hospital REIT ETF or the best skilled nursing REIT ETF, OLD is as close as it gets.
Unlike its ticker symbol, the fund is actually quite young, having debuted in June of 2016. It tracks the performance of the Solactive Long-Term Care Index. OLD currently holds 38 stocks. Its top three holdings are Ventas Inc (NYSE:VTR), Welltower Inc (NYSE:HCN), and Orpea SA (EPA:ORP). (Source: “OLD-The Long-Term Care ETF,” Janus Henderson Investors, last accessed July 12, 2017.)
Because of its focus on healthcare REITs, OLD ETF is able to offer a handsome dividend yield of 3.21%. The fund’s annual expense ratio is 0.5%.
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