Healthcare Etf: Smart Investment Or Risky Move?

Investing in healthcare ETFs can be a great way to get started in the healthcare industry without having to analyse individual companies. Healthcare ETFs offer diversification, reducing your risks compared to buying individual stocks. Healthcare is a resilient sector of the economy with significant avenues for growth. As people are living longer, medicine has a host of diseases to fight, including cancer, heart disease, and Alzheimer's. US healthcare spending has also been above-trend for decades, with a 4.1% increase in spending per capita from 2021 to 2022.

There are several types of healthcare ETFs, including broad healthcare, biotechnology, medical devices, healthcare providers, and pharmaceuticals. Each sub-sector offers different specialisations and potential for returns. When investing in ETFs, it is important to consider the sub-sector, investment track record, and expense ratio.

Characteristics of Healthcare ETFs

Diversification and risk reduction

ETFs, or exchange-traded funds, are an excellent way to gain exposure to the healthcare sector without having to analyse individual companies. Healthcare ETFs can provide diversification and reduce risk compared to investing in individual stocks.

The healthcare sector is vast and can be divided into sub-sectors, such as biotechnology, medical devices, healthcare providers, and pharmaceuticals. By investing in a healthcare ETF, you can gain exposure to a broad range of companies within these sub-sectors, reducing the risk associated with investing in a single company or industry.

For example, the Health Care Select Sector SPDR Fund (XLV) is a broad healthcare ETF that tracks the Health Care Select Sector Index. It includes companies from various industries within healthcare, such as pharmaceuticals, healthcare providers, biotechnology, and health care equipment. This diversification helps reduce the risk associated with investing in a single company or industry within the healthcare sector.

Another example is the iShares U.S. Healthcare ETF (IYH), which is designed to provide broad exposure to the Healthcare – Broad segment of the equity market. This ETF has holdings in approximately 111 companies, effectively diversifying company-specific risk.

Healthcare ETFs can also provide exposure to a large number of holdings, further reducing risk. For instance, the Vanguard Health Care ETF (VHT) has about 416 holdings, allowing investors to diversify their portfolio across a wide range of healthcare companies.

In addition to diversification, healthcare ETFs offer other benefits such as low costs, transparency, flexibility, and tax efficiency. They are excellent vehicles for long-term investors seeking exposure to the healthcare sector while minimising risk.

When considering a healthcare ETF, it is important to look beyond diversification and risk reduction. Investors should also consider the ETF's sub-sector, investment track record, and expense ratio to ensure they are buying the right product for their investment goals.

Healthcare spending trends

The US spent $4,464.4 billion on healthcare in 2022, or $13,493 per capita. This accounts for 17.3% of the GDP, similar to pre-pandemic shares (17.5% in 2019) after a slight uptick in 2020-21 due to the pandemic.

Breaking down the spending, the largest categories were:

• Nursing care facilities
• Other personal healthcare costs
• Government administration
• Net cost of health insurance
• Government public health activities

The second-largest category, physician services, grew by 2.6% in 2022, slower than the average annual growth rate of 4.2% from 2012 to 2022. Hospital care spending grew by 2.2% in 2022, with a three-year average annual growth rate of 4.4%. Prescription drug spending grew by 8.4%, with increased utilisation of retail prescription drugs driving this growth.

From 2020 to 2022, spending on retail prescription drugs experienced the fastest growth at 7.6%, while average spending growth for hospitals and physicians/clinics was 3.4% and 4.0%, respectively.

Looking at the sources of funding, the federal government sponsored 33% of total health spending, and households accounted for 28%. Private businesses made up 18% of the spending, state and local governments 15%, and other private revenues 7%.

Per capita out-of-pocket expenditures increased in 2022 to $1,425 on average. However, real out-of-pocket spending remained relatively stable, decreasing slightly from $1,428 to $1,425.

Health insurance is a growing share of total health expenditures, with private insurance expenditures representing 28.9% of total health spending in 2022, up from 20.4% in 1970. Public insurance, including Medicare and Medicaid, represented 43% of overall health spending in 2022, up from 22% in 1970.

Health spending as a share of GDP fell to pre-pandemic levels in 2022, at 17.3%. However, it is projected that by 2032, health spending will account for 19.7% of GDP, with average NHE growth (5.6%) outpacing GDP growth (4.3%).

Top holdings

When considering investing in a healthcare ETF, it is important to look at the actual holdings inside the fund. Most ETFs are transparent and disclose their holdings daily.

The iShares U.S. Healthcare ETF (IYH) has a heaviest allocation in the healthcare sector, about 100% of the portfolio. Its top holdings include Eli Lilly (LLY), which accounts for about 11.44% of total assets, followed by UnitedHealth Group Inc (UNH) and Johnson & Johnson (JNJ). The top 10 holdings account for about 54.89% of total assets under management.

The Health Care Select Sector SPDR ETF (XLV) also has a 100% allocation in the healthcare sector. Its top holdings include Eli Lilly + Co (LLY) at about 11.81% of total assets, followed by UnitedHealth Group Inc (UNH) and Johnson + Johnson (JNJ). The top 10 holdings account for about 57.02% of total assets under management.

The Vanguard Health Care ETF (VHT) is another ETF with a 100% allocation in the healthcare sector. Its top holdings include Eli Lilly & Co (LLY) at about 10.95% of total assets, followed by UnitedHealth Group Inc (UNH) and Abbvie Inc (ABBV).

The iShares Global Healthcare ETF (IXJ) is a fund that tracks the S&P Global 1200 Healthcare Sector Index. It has $4 billion in assets and an expense ratio of 0.41%.

The iShares U.S. Healthcare ETF (IYH) is a good option for investors seeking exposure to the Health Care ETFs segment of the market. It has a Zacks ETF Rank of 2 (Buy), based on expected asset class return, expense ratio, and momentum, among other factors.

The Health Care Select Sector SPDR ETF (XLV) holds a Zacks ETF Rank of 1 (Strong Buy) and is also a great option for investors seeking exposure to the Health Care ETFs segment of the market.

Performance and risk

When considering investing in healthcare ETFs, it is important to evaluate their performance and associated risks. As of December 2024, the iShares U.S. Healthcare ETF (IYH) has a year-to-date return of approximately 8.98% and has increased by about 13.49% over the last 12 months. In the past 52 weeks, it has traded between $55.11 and $66.38. The ETF has a beta of 0.68 and a standard deviation of 14.42% over the last three years, indicating a medium risk level. With approximately 111 holdings, IYH effectively diversifies company-specific risks.

The Vanguard Health Care ETF (VHT) has experienced similar performance, with a year-to-date return of about 8.84% and a 14.93% increase over the last year (as of November 2024). Over the past 52 weeks, it has traded within a range of $235.53 to $288.10. VHT has a slightly higher beta of 0.71 and a standard deviation of 14.78% over three years, still placing it in the medium-risk category. With a substantial number of holdings (approximately 416), this ETF also effectively mitigates company-specific risks.

The Health Care Select Sector SPDR ETF (XLV) has a year-to-date return of roughly 8.88% and has increased by approximately 13.09% over the last 12 months (as of December 2024). During the past 52 weeks, its share price has fluctuated between $131.85 and $157.24. With a beta of 0.67 and a standard deviation of 14.17% over three years, XLV is also considered a medium-risk investment option. Despite having fewer holdings (approximately 64) compared to the previously mentioned ETFs, it still provides adequate diversification to reduce company-specific risks.

Overall, these healthcare ETFs have demonstrated relatively consistent performance, with year-to-date and 12-month returns varying within a narrow range. They are considered medium-risk investments due to their beta values and standard deviations. The number of holdings in each ETF contributes to effective risk mitigation by reducing the impact of individual company performance.

Expense ratios

When considering investing in healthcare ETFs, expense ratios are an important factor in the return of an ETF. In the long term, cheaper funds can significantly outperform their more expensive counterparts. The expense ratio of an ETF reflects how much it costs to operate an ETF and is typically expressed as a percentage of a fund's average net assets. This percentage can include various operational costs and annual fees. For example, if you invest $10,000 in an ETF with an expense ratio of 0.04%, you'll pay $4 to the fund's manager in a year. As the value of your investment grows, so will the amount you pay.

The average expense ratio for index ETFs is typically lower than that of index mutual funds, historically 0.52% for ETFs versus 0.85% for mutual funds. Importantly, the higher costs of mutual funds can add up and impact portfolio returns over time. The average expense ratio for index equity ETFs declined by 15% from 2008 to 2023, and the average expense ratio for index bond ETFs fell by 30% during the same period. In 2023, the average expense ratio for index equity ETFs was 0.41%, and for index bond ETFs, it was 0.21%.

The iShares U.S. Healthcare ETF (IYH) has annual operating expenses of 0.39%, making it one of the cheaper products in the healthcare ETF space. The Health Care Select Sector SPDR ETF (XLV) has even lower annual operating expenses of 0.09%, making it one of the least expensive products in its space. The Vanguard Health Care ETF (VHT) is another healthcare ETF with a low expense ratio of 0.10%.

When considering the cost of an ETF, it's important to evaluate not only the expense ratio but also the total cost of ownership (TCO), which includes trading and holding costs. Depending on your rebalancing size and frequency, trading costs can accumulate and have a larger impact on TCO than any expense ratio difference between two ETFs.

Frequently asked questions