Health care is historically one of the market’s more stable sectors

By: Rudy Luukko   |   October 6, 2020

The quest for a Covid-19 vaccine has provided a shot in the arm to the global health-care sector. At the same time, there’s political uncertainty amid the election campaign in the U.S., the world’s biggest health-care market and the home base of most industry giants. Investors in health-care funds, of which there are more than a dozen Canadian ETF listings (including currency-hedged and unhedged versions), should bear these cross-currents in mind.

The bigger picture, though, is that health care is historically one of the market’s more stable sectors, and one that is very much underrepresented in the Canadian stock market. That, along with positive long-term trends, make health-care ETFs that invest in U.S. and international stocks a worthwhile diversifier for Canadian investors to consider as a complement to the home market.

“It’s one of the very few sectors that have permanent and non-cyclical drivers,” says Paul MacDonald, chief investment officer and portfolio manager with Harvest Portfolios Group Inc. The Oakville, Ont.-based firm’s offerings include the $419-million Harvest Healthcare Leaders Income ETF, an actively managed portfolio of 20 large-cap stocks for which covered call options are written on up to 33% of the holdings to generate regular monthly premium income.

In the shorter term, the nomination by the Democrats of the more moderate Joe Biden instead of the leftist Bernie Sanders has been a positive for the sector, says MacDonald. So has the deployment of massive resources toward Covid-19 treatments and vaccines.

“In many cases,” MacDonald writes in a commentary distributed to financial advisors, “this has shifted the overly pessimistic perception towards the companies seen early in the year, as they now are providing potential solutions for the pandemic.” He expects vaccines to be available by yearend for emergency use and for high-risk patients.

The Harvest ETF is overweight in big pharma, which recently constituted nearly half the portfolio. “One of the things we like about pharmaceuticals is, in terms of recessions, they tend to perform relatively well,” says MacDonald.

He adds that consumers tend to buy drugs in both up and down equity markets. “Having that relative visibility into cash flows and earnings we think is a valuable attribute, in particular for the current environment.”

MacDonald doesn’t expect the outcome of the Nov. 3 election to result in major changes for the health-care industry. “Drug pricing in particular is a political lightning rod for the politicians,” he says, adding that some minor changes may occur. “There’s always that tail risk but we think the political risk environment has actually subsided.”

History supports MacDonald’s benign thesis, based on Harvest’s examination of the past eight U.S. election cycles, looking at various periods of up to 18 months before and after the election dates. “We can’t actually find any specific correlation between elections and health-care sector returns, despite it being one of the topics that quite often comes up in an election,” he says.

In sharp contrast to the Harvest ETF, the $447-million BMO Equal Weight US Health Care Hedged to CAD Index ETF and its almost 60 holdings held less than 11% in pharmaceuticals, versus 29% for the S&P 500 health-care index.

“Certainly there’s a lot of interest in vaccine development,” says Chris Heakes, director and portfolio manager, ETFs, with Toronto-based BMO Asset Management Inc. “The word of caution I would throw out there to investors is there are going to be winners and losers in this hunt for the vaccine from an investment point of view.”

Heakes says that while president Donald Trump “is essentially a status quo choice” for the health-care industry, Democratic nominee Biden may seek to rein in “some of the more egregious examples” of drug pricing. That could be a headwind for the pharmaceutical sub-sector within health care, Heakes believes.

Biotechnology, also underweighted at a recent 12% of the BMO portfolio, isn’t a sub-sector for the faint of heart, either, says Heakes. “Whether a drug gets approved by the [U.S. Food and Drug Administration] or doesn’t get approved can really make or break companies, especially in the short term.”

Heakes says investors who want exposure to health care are probably better off with a well-diversified sector ETF, or even through a more broadly based index like the S&P 500. This will provide access to other health care sub-sectors such as medical equipment and supplies, and managed care.

The health sector benefits from broad trends such as demographic changes and technological advances. Life expectancy has increased, in part due to new treatments and medications. “As we all know, the demand for health care accelerates as we age,” says Heakes, “so we have a group of people who are living longer, and it’s increasing the demand for health care.”

Among Canadian ETFs, the most diversified strategy is that of the $382-million iShares Global Healthcare Index ETF (CAD-hedged), which is designed to replicate the returns of the S&P Global 1200 index of North American and overseas health-care stocks. Its management expense ratio is relatively cheap at 0.65%, though the lowest-cost provider is BMO, at 0.39%.

As a percentage of GDP, health care is in the 10%–15% range across developed countries, says Heakes, so it’s a significant part of the global economy. But that’s not reflected in the Canadian stock market. The S&P/TSX Composite index has less than a 1% weight in health care, and much of that is in volatile marijuana stocks. By comparison, health care, at 14% in the S&P 500 index, is the U.S. market’s second-largest sector.

The resilient nature of health care as a whole was borne out during the severe pandemic-driven downturn in equity markets earlier this year. During that time, the sector was the second best performing in the S&P 500, says Nirujan Kana, director of ETF strategy with CI First Asset, a division of Toronto-based CI Investments Inc.

The $181-million CI First Asset Health Care Giants Covered Call ETF (CAD-hedged) holds an equally weighted portfolio of the 20 largest North American-listed health-care stocks. Fund managers at CI write covered calls on roughly 25% of the holdings to generate income while providing some downside protection.

“There is some risk and volatility in the sector as well,” Kana cautions. “The impact of Covid-19 remains to be seen.” For example, he says if U.S. unemployment remains high, some people may be forced to delay elective surgeries or diagnostic testing, resulting in lower revenues for certain health-care companies.

What s certain is that an allocation to the world’s major providers of big names in health care will provide diversification and growth potential to Canadian investors that isn’t available locally. Kana notes that because of home bias, Canadian investors tend to be overweight in the economically sensitive financial services and energy sectors and underweight in health care.

“Health care is considered to be more of a defensive sector. It can be a nice complement to a portfolio that consists of more cyclical sectors,” says Kana. “People always need medicine and medical care, irrespective of the macro environment.”

 

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